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THERESE WILSON[*]
The 'deregulation' of banking in Australia during the 1980s has been cited as a major reason for banks pursuing profitable transactions and avoiding what they perceive to be higher risk transactions. Whilst the Wallis lnquiry[1] predicted increased competition in the financial services market that would bring about affordable financial services for all Australians, no such competition has emerged.
An effective regulatory response is required from government in order to address the failure of mainstream financial institutions to serve low-income earners adequately. Australian governments have to date focused on 'band-aid' approaches, including trying to regulate inherently exploitative lenders, categorised as fringe credit providers, in the hope that they might continue to serve low-income earners but in a non exploitative manner. The time has come to seriously address the core problem by requiring mainstream financial institutions to serve low-income earners justly and adequately.
This article describes the problem of the lack of financial services for low-income earners in Australia and explores the social consequences of that phenomenon. It then explains why banks should behave as good corporate citizens, and should be recognised as having certain social obligations that extend their role beyond that of profit making. It outlines economic justifications for regulating mainstream credit providers to provide adequate services to low-income earners, and examines possible regulatory models.
The 'deregulation' of the financial system in the 1980s involved removing all official controls on interest rates and restrictions on lending and borrowing. This allowed more entrants into the financial services market and permitted a move to a system based on prudential guidelines and monitoring rather than direct controls.
Banks are now trying to attract and retain what they regard as a 'more profitable' group of customers, and have tended to close banks in areas populated by low-income earners. Fees on savings accounts have increased, and tend to be waived only for customers with home loans or investments with the bank. or members of professional associations. Further, very heavy fees are imposed for defaults such as cheques that bounce or overdrawn accounts. Low-income earners are left without the ability to save in any substantial manner, and without access to 'safe credit'. This results in 'financial exclusion', defined as:
lack of access to financial services by individuals or communities due to their geographic location, economic Situation or any other anomalous social condition which prevents people from fully participating in the economic and social structures of mainstream communities.[2]
Access to credit has become an essential part of access to financial services, given the consumption-driven nature of our society. Most consumers rely on credit in order to purchase what have come to be regarded as essential items such as refrigerators, washing machines and television sets. Lack of access to credit through mainstream financial institutions has resulted in low income earners turning to what have been termed 'fringe credit providers', with the unfortunate result that low-income earners pay more for credit than other consumers. There has been an increase in recent years in the number of fringe credit providers, which charge very high interest rates, and target their products at lowincome earners.
One example of a fringe credit provider is a 'payday lender'. Payday loans are short-term loans, usually for a period of 14 days (the premise being to 'tide borrowers over' until the next payday), typically for a small amount in the vicinity of $250. There is no annual rate of interest charged, although significant fees are attached to the loan. It has been sought to require payday lenders to disclose these fees in terms of an annual percentage interest rate under the Uniform Consumer Credit Code, as 'interest' is defined at common law as the profit earned by the credit provider, whereas fees should properly represent the true costs of the loan for the lender.[3] When converted to an annual percentage interest rate, the fees charged on payday loans can range between 235% and 1300% per annum.[4] When loans are not
repaid by the due date, there tends to be an option to 'roll over' the loan for a further, say, 14-day period, upon payment of an additional loan fee. This can result in borrowers paying, over a period of time, an amount well in excess of the original loan amount, without being credited with any loan repayments against the principal owing. In one example, a couple who borrowed $50 in July 1999, and rolled over the loan every fortnight on payment of the appropriate fee, owed $980 to the payday lender with a fortnightly fee payable of $196 by May 2000.[5] Borrowing from a payday lender can be 'the beginning for many of an uncontrollable debt spiral,[6] With the increase in the number of high interest credit options being offered to low-income earner in recent years, there has been an explosion in the level of bankruptcies, particularly for young people report payday lending in Victoria has argued for the introduction of non-exploitative lending to meet the demand for short-term loans:
Despite an obvious market, competition has failed to provide low-income consumers with short-term credit at rates comparable to those for more affluent consumers. Low-income consumers have identified the sort of financial product they require. It is a matter of social equity that it be provided to them at a fair and just price.[7]
Failure to meet the financial needs of low-income earner allows a situation to continue whereby a group is excluded from full social participation as a result of being marginalised from financial services. Banks, as mainstream financial institutions, are obvious candidates for providing those services.
Banking should arguably be regarded as an essential service. It has been suggested that:
It is not sufficient to argue that banks are now like any other competitive business whose primary business is to maximise the return to the shareholder. The major banks, because of their key role in the financial system have a utility function that confers responsibilities beyond that of ordinary business.[8]
It has been argued further, in relation to banks, that 'the scale of their assets and the influence they have on the economy are so vast as to place them in a unique position, one which may carry with it special duties as well as rewards.'[9] Even leaving aside the unique position of banks, they, like many other businesses, are entities that receive contributions from and serve their owners, employees, and consumers, all of whom contribute and are entitled to have certain expectations met
Banks themselves have recognised a broader social responsibility that takes their role beyond that of profit making. The 'Code of Banking Practice' that commenced in August 2003, recognises an obligation on the part of banks to meet the needs of elderly or disabled customers, as well as low-income earners or otherwise disadvantaged persons. However, the stated obligations in respect of low-income earners are limited to providing them With details of accounts suitable to their needs. In a speech given in October 2000, the then chair of the Australian Bankers' Association noted that:
Because banking is such a fundamentally important service, pricing and access must meet the needs of every member of the community ... The point I want to emphasise is this. We do acknowledge that we have a social responsibility ... a responsibility to the communities where we conduct our bus1ness that goes beyond provid1ng banking and financial , services.[10]
There are two economic justifications for regulating banks with a view to ensuring low-income earners have adequate access to mainstream financial services. These justifications are market failure as evidenced by a lack of competition in the market for providing financial services to low-income earners, and evidence that loans to low-income earners may be profitable and that the lack of lending to this group may be due to inadequate information. Regulation can be justified where the unregulated market has failed to reach the desired outcomes.
The evidence is that low-income earners are currently paying high fees on savings accounts, and exorbitant interest rates on short-term loans. This demonstrates a lack of competitive services in this market Abdicating responsibility for regulation to the market and to the 'power of consumer preference' assumes that markets will be 'arenas of surveillance'.[11] This is unlikely to be the case in the absence of competition. Desperate borrowers, for example, without access to mainstream credit, are likely to borrow from fringe credit providers notwithstanding the high interest rates being charged. A consequence of lack of competition amongst financial institutions to provide services to low-income earners is an inequality of bargaining power between those low income earners and those institutions offering to provide services to them. Economic arguments in favour of freedom of contract and limited regulatory intervention tend to assume that both parties to a transaction have equal bargaining power and are in a position to negotiate contractual terms. In the case of fringe credit providers such as payday lenders, there is a clear inequality of bargaining power and an inability on the part of borrowers to negotiate more favourable terms. Borrowers are simply provided with a copy of the loan contract on 'standard terms'. A similar lack of choice and bargaining power arises in relation to savings account fees for low-income earners, apparently due to closures of banks in low-income areas and limited interest on the part of banks in servicing this sector of the community.
In relation to the lack of competition in this market, it should be acknowledged that financial services are being provided to low-income earners to some extent by community organisations. However, they provide only a limited solution to the problem. For example, No Interest Loan Schemes (NILS) are run by community organisations for consumers who are unable to access affordable commercial credit to buy essential items such as washing machines and refrigerators. The loans are generally between $600 and $1000, and one year is allowed for repayment. Funds tend to be derived from philanthropic trusts and the corporate sector. In general, banks have declined to contribute, with the Australian Bankers' Association stating that the primary responsibility for such a scheme should sit with the government 'who have the necessary expertise in targeting welfare assistance to make the scheme effective and accountable.'[12] Unfortunately these loans are only available to those whose primary source of income is social security, to be used for purchasing essential items, and not for general living expenses.
There is also the 'savings and loans group' model of 'micro finance' promoted by groups such as Foresters ANA Friendly Society Limited where members of the group make regular contributions to savings and can borrow at no interest. It is anticipated that these loans will be limited to periods when members are 'experiencing unexpected financial hardship,'[13] and in that sense can be seen as a form of community insurance.
The second reason for market failure in relation to the provision of financial services to low-income earners may be that inadequate information is available concerning the risk of lending to this group, leading banks to miscalculate the risks. Banks 'increasingly view people living on low incomes as increased credit risks, even though there is a wide body of evidence to suggest this is a myth.'[14] Interestingly, the payday lending industry has advised of relatively low levels of default on payday loans, typically in the 2-3% range.[15]
In the United States, lenders make extensive use of the information contained in consumer payment histories. That information is applied to scoring models in .order to assess risk and decide whether or not to lend. In Australia, under the Privacy Act 1988 (Cth), only negative reporting of credit histories is allowed, that is, information on defaults and bankruptcies, not on positive account payment histories. A study has been conducted that demonstrated that the detailed credit history available in the United States greatly enhanced the accuracy of the 'risk scoring' process. The study took credit information and applied it to a risk scoring model in order to assess the credit risk of certain individuals and decide whether or not to lend to them on the basis of an acceptable percentage default risk The limited negative information available in Australia was applied, and then the more extensive information available in the United States. One example of the findings was that, using a target rate of 4% defaults on loans, 76.5% of the sample group would have obtained the loan in the United States, whilst only 57% would have obtained the loan in Australia. The conclusion drawn from the study was that, due to the lack of information available to lenders in Australia, consumer credit is less readily available in Australia than in the United States and that:
This effect will be especially noticeable for those consumers who are financially more vulnerable (higher risk categories) such as consumers who are young, have short time on the job or at their residence, and lower incomes.[16]
It is notable that the payday borrower in Australia is likely to fall within this description, in that he or she is likely to be aged in his or her late twenties or early thirties, on an income (from either a full-time job or social security) of approximately $24,000 per annum. Whether or not positive credit reporting is desirable is a contentious issue, given a general suspicion of corporate information gathering. However, the study referred to certainly provides some evidence that if these borrowers were given the opportunity to develop credit histories, then they may prove to be lower risk borrowers than might have otherwise been assumed. Further, given the relative youth of this demographic, financial institutions should consider offering low-cost, and not risk-adjusted, loans to these borrowers, with a view to maintaining their business and profiting from them when they become a 'better quality' borrower.
The question that remains to be answered is how to regulate mainstream financial institutions such as banks, in order to ensure that they provide adequate financial services to low-income earners. The article now explores the possibilities of providing monetary incentives to banks, of making the existing privilege of a banking licence contingent on fulfilling community service obligations, and of a model of enforced self regulation, where banks would outline appropriate community service obligations in their code of conduct, subject to external enforcement where required.
Goverrlment business enterprises (GBEs), which have been 'corporatised' to run in a more 'business-like manner. will still be required to provide services to the community that are not profitable, and that they would not elect to provide on a commercial basis. These services are described as community service obligations (CSOs), and the GBEs receive government reimbursement based on the cost of providing that service (assessed as the cost that would have been avoided had the service not been provided). It is possible that this approach could have application in the private sector, so that where banks are required to provide financial services to low-income earners which they would not elect to do on a commercial basis, those s rvices should be regarded as CSOs, requiring government reimbursement However, as stated above, it cannot be assumed that those services will necessarily be unprofitable, and banks would need to demonstrate to government that they have incurred costs as a result of providing, the financial services in question.
Another form of monetary incentive might be a tax incentive. In the United Kingdom, a Social Investment Task Force has recommended large tax incentives be provided for financial institutions investing in disadvantaged communities. This investment is to be made through intermediary bodies known as 'community development finance institutions', which provide finance to business enterprises in disadvantaged communities.[17] Such a tax incentive could apply in Australia. for example, to investment in NILS, or in organisations promoting 'micro-finance' such as Foresters ANA Friendly Society Limited. This would involve an extension of, and government support for, initiatives such as those currently undertaken by ANZ in partnership with Brotherhood of St Laurence, and Nation! Australia Bank in partnership with Good Shepherd Youth and Family Service.
However. this raises the question of whether additional monetary benefits should be provided to banks for fulfilling what are a part of banks' community service obligations in any event Arguably, it would be more appropriate to make existing privileges, such as the continued holding of a bank licence, dependent upon fulfilling those obligations and providing adequate services for low-income earners.
The introduction of legislation such as the Community Reinvestment Act, enacted in the United States in 1977, could be considered. That Act requires periodic evaluation of the performance of financial institutions in meeting the credit needs of their communities, including the needs of low and moderate-income earners. That record is taken into account in considering an institution's application for deposit facilities, including in the case of proposed mergers and acquisitions.[18] In Australia, the Australian Prudential Regulatory Authority (APRA) is responsible for prudential supervision of financial institutions, and could undertake responsibility in relation to monitoring community obligations. APRA has the power to impose specific conditions on a bank's licence where a bank chooses not to comply with prudential. statements that have been issued. A similar process of imposing conditions could be applied in relation to a failure to meet appropriate community service standards.
A precedent has been set in the United States whereby the need to regulate in relation to ensuring access to financial services by low-income earners has been recognised. As one commentator has noted:
The most pertinent lesson for the Australian context is that the US government, who are renowned for avoiding regulatory intervention, have seen the need to Intervene on this issue, and have persisted with the CRA for more than two decades, and that numerous poor urban communities have benefited as a result Further, US banks (including some with Australian links) have not suffered as a result of this type of regulation.[19]
Another approach would be to adopt a model of enforced self-regulation, which can be described as the public enforcement of privately written rules. This model is based on the members of an industry writing their own regulatory rules, which would then be approved by a government regulator, and which become enforceable by the government regulator. There are two recognised advantages of this model. First, it gives banks the opportunity to 'internalise' concepts of community service obligations, so that they are committed to them. There might be a lack of commitment on the part of the banking industry, were the obligations simply to be legislatively imposed. The second advantage is said to be that rules written by industry members will be well informed and therefore more effective and appropriate.
The model could utilise the existing Code of Banking Practice with some amendment For example, the Code could require banks to provide basic credit facilities, similar to basic bank accounts, perhaps extending the model being trialled by National Australia Bank referred to as the 'Step Up' program. This involves loans of between $800 and $3000 being made to low-income earners at a fixed interest rate of 6.9% for the purchase of household goods and services.
Clause 34 of the Code already provides for the establishment of a Code Compliance Monitoring Committee, responsible for monitoring compliance with the Code and naming banks in connection with Code breaches. A regulatory authority, such as APRA, could also be given responsibility to enforce sanctions against banks that did not comply with the community service obligations set out in the Code or it could impose conditions on banking licences where those obligations had not been complied with.
Clearly, the effectiveness of this model will depend upon the regulator being adequately resourced, and upon penalties for non-complying banks being sufficiently punitive. This might avoid the perceived failings of the 'co-regulatory' regime established for the regulation of the telecommunications industry in Australia, in terms of consumer protection.
This article has described a social problem that has arisen as a result of the failure by mainstream financial institutions to serve low-income earners. The solution proposed is that banks be subject to regulation to ensure that low-income earners have access to affordable and 'safe' financial services in Australia. Economic justifications for regulation have been outlined, namely the market failures demonstrated by both a lack of competition in the low-income market, and a lack of adequate information concerning the risk of lending in this market. Proposed models of regulation that have been outlined include monetary incentives, adverse consequences in relation to a bank's licence, and enforced self-regulation. The latter model has the advantages of encouraging industry commitment to rules and well-informed rule making.
The enacting of the Community Reinvestment Act in the United States over 25 years ago provides some precedent for the need for government intervention to deal with the issue of access to financial services by low income earners. To do nothing and allow the status quo to continue, will be to leave a section of our community both financially and socially marginalised.
[*] THERESE WILSON teaches law at Griffith University Law School.
© 2004 Therese Wilson
email: therese.wilson@griffith.edu.au
[1] The Wallis Report' is correctly referred to as the 'Financial System Inquiry Final Report' (1997).
[2] Chris Connolly and Khaldoun Hajaj, Financial Services and Social Exclusion (Financial Services Consumer Policy Centre, Chifley Research Centre, The University of NSW, March 2001) 4.
[3] Cases that have been referred to on this point include Riches v Westminster Bank Ltd [1947] AC 390, 400; Ridge Securities Ltd v Inland Revenue Commissioners [1964]1 WLR479, 493
[4] Queensland Office of Far Trading, Payday Lend1ng -A Report to the Minister of Fair Trading (2000) <www.consumer. qld gov.au/OFT/OFTWeb nsf/web+ pages/A1 BOFBCF63EE9FA4A256B4400317450? OpenDocument&L1=Publications> at 20 November 2004.
[5] lbid 18
[6] Paul Syvret, 'The Quick and the Debt', The Bulletin, 6 February 2001, 30.
[7] Dean Wilson, Payday lending in Victoria – A Research Report (Consumer Law Centre Victona Limited, July 2002) 82.
[8] Connolly and Hajaj, above n 2, 36
[9] Gareth Griffith, Banks and Community Obligations (NSW Parliamentary Library Research Service, 2000) <www parliament nsw.gov au/prod/parlment/pubhcatlons.nsf/0/ F6BC5248E799C9ECA256ECF0006E6FC> at 20 November 2004
[10] Frank Cicutto, the then Chair of the ABA cited 1n Connolly and Hajaj above n2, 36:
[11] Peter Grabosky, 'Using Non Governmental Resources to Foster Regulatory Compliance' (1995) 8
Governance An International Journal of Policy and Administration 536-542.
[12] David Bell, then CEO of the ABA cited in NCOSS No Interest Loans Development Project Report (Council of Social Services of NSW, October 2001) 2
[13] See Foresters ANA Friendly Society website <www forestersana.com.au> at 20 November 2004
[14] Ibid.
[15] . Queensland Office of Fair Trading, above n 4, 11.
[16] Staten and Barron, The Value of Comprehensive Credit Reports. Lessons from the US Experience' (Paper presented at the Australian Retail Finance Conference, Sydney, 2000)
[17] Connolly and Hajaj above n 2, 30.
[18] See Federal Financial lnstitutions Examination Council website <http://www.ffiecgov> .
[19] Connolly and Hajaj, above n2, 31.
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