Banking code ‘unfair’ to small businesses, Ombudsman tells RC

“Commissioner Hayne reported that the ‘chief protection for small business borrowers… remains the code’, so unless the code delivers fair and equitable outcomes for small business, what’s to stop the banks [from] reverting back to the aggressive behaviour and questionable conduct revealed during the royal commission?” Ms Carnell said in a statement.

“We have examined the code clause by clause and found banks can still change their risk appetite, call in loans with no notice and choose not to work with small businesses to return a loan to performing when impairment has been caused by factors outside the control of small business.”

Redefining small business

One recommendation reiterated by the Small Business Ombudsman is for the banking code’s current definition of small business as an entity with “less than $3 million in total debt” be changed to make the figure less than $5 million instead. This is to cover “capital-intensive small businesses such as agriculture or manufacturing” — a recommendation supported by Commissioner Kenneth Hayne.

The ASBFEO cited a finding from the Khoury review that such an increase would cover an additional 10,000 to 20,000 businesses, further noting that the revision would allow more businesses to fall within the remit of the new Australian Financial Complaints Authority (AFCA), which considers disputes regarding loans of up to $5 million.

Clauses that “offset” intended protections

Further, the Ombudsman pointed out that clauses providing longer notice periods are offset by clauses giving the banks the right to disregard the notice period if they think they need to.

For example, as the ASBFEO notes in its submission, clause 75 requires that when a borrower is in default, 30 days’ notice is to be provided. But this is then offset by clause 77, which states that the bank can provide a shorter notice period, or no notice period, if “based on [their] reasonable opinion, it is necessary”.

The submission also suggested that clause 80 in the banking code, which highlights specific events that will not trigger enforcement action, include entering into a credit repayment plan with the Australian Taxation Office (ATO) as a material event, as the ATO itself encourages small businesses to enter plans so they can manage their cash flow.

Additionally, according to the Ombudsman, clause 84 of the banking code, which states that banks will not include a general material adverse change clause as an event of default, effectively “retains the right of banks to manufacture defaults”, as it means that a material change that is adverse to the borrower cannot be considered as an event of default.

“Obviously, if adverse, it will quickly lead to a borrower being unable to service the changed terms and conditions, leading to an event of default,” the ASBFEO noted in the submission.

It also questioned the independence of the oversight body, the Banking Code Compliance Committee, which comprises board members appointed by bank-funded bodies such as the ABA, as well as the body’s ability to be effective as banks will only comply with “reasonable requests” under clause 213.

“We want the code enforced by a truly independent body, which the Banking Code Compliance Committee is not,” Ms Carnell said.

The Ombudsman additionally raised the point that the code only applies to members of the ABA, yet it’s the “chief protection for small business borrowers”, as Commissioner Hayne noted in his interim report.

“While currently 80 per cent of small business lending is provided by the major banks who are members of the ABA, there are many financial services providers who are not and do not subscribe to any code of conduct or practice,” the submission stated.

“The current policy to increase competition in financial services means there are a growing number of alternative financial service providers.

“While other codes exist, the approach is piecemeal and protections are inconsistent.”

The Ombudsman also suggested looking at how a code of conduct, as well as access to external dispute resolution scheme, can be applied broadly across the financial service sector.

NCCP Act inappropriate for small businesses

Despite the inconsistencies across industry codes, the ASBFEO recommended that small business lending not be included in the National Consumer Credit Protection Act 2009, as the act determines the ability to service the debt based only on historical information, not future projected earnings. 

“A very high proportion of businesses, especially new businesses or businesses looking to expand and grow, would not be able to demonstrate the ability to service the debt on their historical financials alone,” the submission stated.

The royal commission’s interim report had also noted the lack of demand among small businesses for the responsible lending provisions in the NCCP Act to be extended to them due to the view that legal protections limiting the rights in default of lenders providing small business loans would have an adverse effect on the lender’s appetite to grant such loans.

Another recommendation put forth by the Ombudsman is for small business loan contracts to be amended so that they do not contain preset default interest rates (18 per cent).

Instead, the ASBFEO suggested capping the default margin at, for example, 4 per cent above the non-default contracted rate, as well as including a provision in the contract for the lender to charge penalty rates only after clearly demonstrating how the rate has been calculated.

The final royal commission report, which will include recommendations, is scheduled to be submitted to the Governor-General by 1 February 2019.

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