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Parliamentary Joint Committee on Corporations and Financial Services - 18/11/2015 - Impairment of customer loans

LEE, Mr David, Chief Credit Officer, Credit Restructuring, Westpac Banking Corporation

MALCOLM, Mr William, General Manager, Credit Risk, Westpac Banking Corporation

CHAIR: We will resume. The committee welcomes representative of Westpac. Thank you for attending today's hearings. Would you like to make a short opening statement before the committee proceeds to questions?

Mr Malcolm : First of all, I would like to thank the committee for the opportunity to appear today. As I said earlier, I am the general manager for credit for the Westpac Group. I have been in this position since May 2015. Prior to this role I was the chief risk officer for Westpac in New Zealand, and before that I was the chief risk officer for Australian banking. Today I am accompanied by David Lee. David is the head of our credit restructuring group, which deals with customers who are distressed in our business bank.

For almost 200 years the Westpac Group has had a proud history of working with Australian businesses. This long history demonstrates that we support businesses in good times and in bad times. While distress may arise within the business itself, it can also be related to seasonal and cyclical factors. Some submissions to the inquiry suggest that the commercial interests of banks are prioritised over our customers' interests. At the Westpac Group, we consider that our interests and those of our customers are aligned. This is because our success relies on the success of our customers.

The Westpac Group's vision is to help our customers and our communities to prosper and grow. We are genuinely committed to doing the right thing by our customers. These principles guide our approach to customers in financial distress. The effectiveness of our broader credit risk-management framework is demonstrated by our low level of distressed assets. Today we have over 1.2 million commercial and business banking customers. We are currently working with less than 1,000 of them in our specialist credit restructuring group. More specifically, in our agribusiness portfolio, we have over 30,000 customers and only eight have receivers appointed. While this is statistically a small segment, we are sensitive to the affect this can have on our customers and their families. That is why the Westpac Group is engaged in industry initiatives to continually improve support capabilities, including in the area of mental health. Some submissions to the inquiry have commented on the rights afforded to banks under business loan facilities. By its very nature, business lending is more complex than consumer lending. The financial and non-financial covenants in our business loan contracts are both important and necessary. In particular, they also ensure our compliance with our prudential obligations. Non-financial covenants act as an important early warning signal of potential business distress and provide a trigger for a two-way conversation. We consider that we apply these covenants in a transparent manner.

We understand the committee is concerned with the use of constructive defaults in business lending, in particular the reliance on loan to value ratio, or LVR financial covenants. I would like to emphasise that the Westpac Group does not engage in practices to artificially engineer a business default, including by the revaluation of security. We do not currently have any matters under recovery subject solely to an LVR default. We have gone back over our recent history, back to the time of the St George merger, to see whether there are any other cases of using only an LVR default, and we could not find any.

When the Westpac Group works with distressed customers, our focus is on rehabilitation and returning those customers to good business health. Our preference is to work directly with our customers to discuss alternative solutions before we seek to rely on the enforcement of security. We understand that these processes can take some time and that is why we work with our customers over months or even years before we decide to progress with enforcement. When a matter does proceed to enforcement, we consider our internal processes are working well and that the existing regulatory regime is adequate and appropriate. However, we are by no means infallible. We do make mistakes and within our processes we try to resolve these as quickly and fairly as possible.

I would like to end by reinforcing our genuine commitment to assisting this inquiry and supporting our customers in financial distress. We do not consider that the changes to the legislation or self-regulatory regimes are necessary; however, we remain committed to continuous improvement, including in our loan documentation. This documentation is currently being reviewed as part of our implementation of the unfair contract terms act. We would also be happy to discuss other partnership opportunities between the government and industry, including the national harmonisation of farm debt mediation. Thank you, I will be happy to take questions from the committee.

CHAIR: If I could take you to a comment in your opening statement and also on page 3 of your submission that you have not had a case of default purely based on LVR since your merger with St George. Evidence we have heard to date from various witnesses indicates that there are normally several grounds for default ranging from being out of the country too often to being late with a tax return or some other mechanism. LVR is part of that. Can you take on notice how many defaults you have had, including during the St George merger through to now, where LVR is one of perhaps only two or three? I understand you can isolate the solely, but I am interested to know how often that is a part of your consideration. My second question is about when you merged with St George. Clearly there have been issues raised about ANZ taking over Landmark and the Commonwealth Bank taking over Bankwest. In terms of that merger, did you also see, particularly given that we were in the middle of the GFC, a spike in the number of impaired loans during that period?

Mr Malcolm : Yes, we did. There was definitely an increase in stress in our book. The stress level in our book at the moment is less than one per cent, in our latest published figures. At the peak of the GFC that was up at three per cent. We definitely saw a peak. It has come down since. Certainly in business lending we did see stress, particularly within the property sector. We did see falling property values, particularly in certain parts of Queensland and Western Australia where stress was most particularly evident. We did see falls in property values and stress, particularly within the property industry.

Mr RUDDOCK: Excuse my interrupting, but I thought the GFC and the St George takeover were at different times?

Mr Malcolm : The merger was effective on 1 December 2008.

Mr RUDDOCK: It was contemporaneous?

Mr Malcolm : Yes.

CHAIR: We have heard evidence from another bank, not the Commonwealth Bank, that the concept of warranty provisions or clawback provisions is a standard part of merger activity. Particularly where there is a time frame consideration, where one party may not have done sufficient due diligence but both parties are keen for the merger to occur, those kinds of warranty provisions are incorporated. Was that part of your merger with St George?

Mr Malcolm : No, it was not, because it was a merger. I think the circumstance of Bankwest, if that is what you are talking about, is the sale of a subsidiary from one company to another where there is someone ongoing to provide an indemnity or a clawback provision. In the case of St George, it was a merger. On the merger we assumed the assets and liabilities of the St George group, so there was no-one to take an indemnity from.

CHAIR: We have had some evidence from people who feel as though they engaged with what they are calling second tier banks—St George, Bendigo or whoever—and were given a facility on one set of terms and conditions but then when one of the big four banks took them over, or in this case merged, they were then held to a new and higher standard. Could you just talk to the committee about whether there was any difference between the standards under which money was lent by St George and those which Westpac requires, or were the conditions that people borrowed money from St George grandfathered, if you like, through to the remaining term of their contract?

Mr Malcolm : No two banks are going to have exactly the same policies. If you have a merger, there will be some sort of alignment of policies post that merger. There were differences in underwriting standards and policies between St George and Westpac. Post the merger we tried to align those as far as we could, but obviously any contractual terms that were afforded under the St George merger, we honoured.

The nature of the merger or the idea behind the merger with St George—we did not change the branding of St George; we kept all of the same people at the front line—was that you should not see any change in dealings, that you deal with the same people, the same bankers and so on, under the same conditions that you had previously. In a typical merger there will be an attrition of customers that will leave the bank. Our catchphrase was that we did not want to lose a single customer. In order to do that, as far as we could, we wanted to keep the same bankers, the same branding and the same front of house view for our customers but use the scale and benefits of the Westpac corporate entity and have the more advanced credit risk management and other benefits of having a single entity.

CHAIR: To go to that spike of three per cent that you said occurred immediately after the merger, were people caught up in that? Were their loans deemed to be performing loans under St George's terms and conditions but then deemed to be non-performing loans under Westpac's new standards?

Mr Malcolm : Not as a result of the change of policies. It would have been a change of circumstances. Just as there was in the Westpac book at the same contemporaneous period of time, there was an increase in defaults and stress for the same reasons that there was distress and default within the St George book. In some circumstances it was higher in the St George book, but that was not due to having a different policy standard; it was just that it would have been written under a different policy, so there was probably more leverage in the companies, or it was written under an easier or looser standard, so it was more vulnerable to stress when that actually occurred.

CHAIR: On page 14 you say that customers require sufficient notice of the bank's intentions. What do you deem to be sufficient notice? Again, we have had evidence that sometimes people receive 24 hours notice, a week's notice, two weeks' notice or a month notice to take certain actions. What standard does Westpac apply?

Mr Malcolm : I might start to answer that question, and then, if I may, I might pass over to David because he is involved in this on a day-to-day basis. In general, there is a concept of working with the customer—once you first identify that they are having business problems or stress, you work with them with the intention of rehabilitating them. That can take a period of months or even years, but, once it has gotten to a point where you are going to take enforcement action, the period of time can be quite short because of issues around trading while insolvent and protecting the value of those assets.

Mr Lee : Could I just clarify: by notice, do you mean demand—if we serve a demand on the customer?

CHAIR: That is one action, but there are a number of bits of evidence we have received where banks have either appointed receivers without advising the customer that that is going to occur, or they have demanded action within a timeframe that other witnesses have said is unrealistic—such as registering a title of a property so that the bank can register its interests in one part in less than 30 days—and they have been defaulted because they have not met that condition, even though the condition was probably inappropriate.

Mr Lee : There would be conditions within the loan agreement. As David said, we work with our customers, and we reach a commercial agreement with them in terms of any changes to the facility agreement. If we stipulate certain time periods for things to occur, we will agree to that with the customer—so that may be, as you said, to register a property. To register, we will give them a time period and we will say this is the time period that we think is reasonable, and the customer can then come back and say, 'No, I think that is unreasonable'. Then it will be a negotiation in terms of what that time period is.

If it is something like serving a demand, it depends on the circumstances at the time. For example, a customer will get a short period of time if it relates to administration, liquidation or receivership, or where there are fraud or animal welfare considerations to be taken into account. That short period of time can be anything from 28 to 48 hours. In terms of other notices in terms of demand, it could be a longer time for other reasons, and that could be seven to 14 days in terms of a time period.

CHAIR: Rather than you guys sitting in your corporate headquarters, if you subsequently found that, at a line level, people had demanded contract signature or signing of an agreement with only 24 hours for somebody to look at an agreement, get their own legal advice et cetera, are there procedures within your bank to go back and revisit that in favour of the lender? Can you give us examples where those have been enacted?

Mr Malcolm : There is a general internal code of conduct, and if we were behaving in that way—coercing customers into forcing them to sign an agreement—and we found out about that or there was a complaint about that, we would certainly take action against the individual, but we would also look at what the consequences were of that action and try to redocument it or come to an agreement with the customer. Is that correct?

Mr Lee : That would be correct.

CHAIR: Who would the customer complain to in that case? Can I put it in context: we have had a number of people give us evidence that they had reached an agreement—paperwork had been promised. Less than six hours before the cut-off time the paperwork was finally delivered, but they were still told they had to sign on that night or the whole deal would be off. In a case like that with Westpac, who would they ring to complain? What is the mechanism that is advertised for them to make a complaint?

Mr Malcolm : We have various avenues where you can complain. You could complain to your banker—the person who has done that originally. You could complain to his manager.

Mr RUDDOCK: You used to be able to ring Gail.

Mr Malcolm : You could ring Brian if you wanted to, but we do have ways, both online and by telephone, that you can lodge a complaint with us. You can also write to the bank as well—email the bank. It is clear on our website what the opportunities are to provide a complaint about service or fees or anything.

CHAIR: Sure, but if I send an email or letter, my experience, generally speaking, is that the bank will send back a reply saying, 'Thank you. We appreciate your correspondence. We will undertake to get back to you within 48 hours,' or two working days, or whatever. In some of the cases we have received, the time frame is much shorter than that. What I am hearing is that there is no dedicated process where a customer can get a real-time answer to a complaint of that kind of magnitude.

Mr Malcolm : I would say that our complaint procedures are pretty robust and actually we have got a pretty good record of reducing the number of complaints that we get. The reasons for complaints can be many and varied. If it is a serious issue like that, I would posit that we would take it seriously.

CHAIR: At page 15 of your submission you say:

State based legislation regulates the timeframes and requirements for a mortgagee to exercise a power of sale.

I am happy for you to take this on notice, but what are the differences between each of the states and territories in Australia that Westpac sees?

Mr Lee : I do not have that detail with me. I would have to take that on notice.

CHAIR: I am happy for you to take that on notice.

Mr LAUNDY: Mr Malcolm, I am very happy to hear, in the last or second last paragraph, that you are after suggestions for loan documentation rewrites, because I want to throw a concept at you that I threw at the Bankers' Association earlier today. You offer a customer a loan with a margin built in. Within your loan documentation you have the flexibility to change that margin, and in the worst case scenarios there are, indeed, written in that documentation, default penalties of interest. I have always found LVR to be an interesting concept in terms of banking, because the major determinant of market caps is availability of credit. Banks are the providers of credit, so I have always found the possibility of a vicious circle—market caps go up and down over time. Therefore, I have always been of the opinion that interest rate cover was a far more important measure of business health.

If there is a business that has strong interest rate cover but its LVR goes out of whack, historically what this committee has seen, and what I have seen in my former life as a hotelier in the pub industry, is that the bank will come in, it will increase the margin sitting above the loan and it will book the revenue as interest revenue in consolidated revenue. If the interest rate cover was strong but the LVR was out of whack for a period of time, would it not be more constructive for the bank to work with the customer to use the increase in margin that you would normally book as profit to decrease the principal of the loan? I think that, in that environment, you are looking after both the shareholder and the customer. I get that there may be a re-rating of risk to a point; I get that. But when interest rates hit—and this committee has had instances detailed to it of 16 and 17 per cent—I am worried and I am wondering whether there is a point inside that loan documentation that a re-rate of risk could move from being penal to something that is actually constructive.

Mr Malcolm : Thank you for that question and that suggestion. I am happy to work with you on that, but let me try to piece together the concepts you have outlined there and I will try to play them back to you to see if I have got it.

In terms of the way that credit margin works on a bank loan: as you rightly point out, it is due to the credit risk of that customer. You have hit on the two concepts within 'credit risk'. What we call them—and apologies for the bank jargon here—is a 'probability of default', which is measuring exactly what you talked about: the interest cover ratio. That is the amount of cash flow that is coming into the business that is able to pay creditors and debt in that business. That is very important. We call that the first way out, and that is what we always want repayments to come from; we do not want it to go to the LVR which is, in bank jargon, the loss given default, and that is the security we realise in the case where someone has actually gone to default.

Mr LAUNDY: Worst-case scenario?

Mr Malcolm : When we talk about credit risk in total we are talking about the probability of default times the loss given default. That gives you your expected loss. When we are looking at the credit risk in total we are actually looking at both concepts. When you are talking to APRA, the amount of capital you have to hold is a function of both the probability of default and the loss given default.

In the scenario that you built up there—apologies if I am going on a little bit here—the probability of default is probably more determined by the interest cover ratio than it is by the loan-to-value ratio. Both are important concepts, but both are measures of creditworthiness. It would be unlikely if you had someone who is really covering all payments and had a strong and high interest cover ratio that you would unilaterally increase their credit margin, absent any other issue in the market. You would not change their risk rate, which is really determined by their probability of default.

You could, in your annual review of the customer, say that the value of the security had gone down because of market conditions and that our loan-to-value ratio had gone up, so this customer is more risky in total. You would sort of say, 'Let's increase the margin.' That is a little bit about how credit margins work. We are trying to say that creditworthiness is not just one or the other, it is actually both. It is related to both of those in terms of the amount of capital we have to hold for that facility, and therefore the return that we are getting on that facility.

But what I would say is that we could indeed say we are not going to increase their credit margin and allow them to pay off more principal. But remember that at any time you can pay off more principal, we do not penalise you from paying of more principal.

Mr LAUNDY: Only if you want to! I guess that the concept which is front of mind, in a lot of ways, is what has happened anecdotally, as presented both to this committee and historically in the hotel industry—particularly through the GFC period. You get to levels which can only be described as 'gouging'. It is not you personally; this is the anecdotal evidence that we have been presented with. If that is the case, if the business is healthy enough to sustain that level of fee being charged, surely a good banker would work with the customer to use that surplus of cash flow to decrease exposure?

Mr Malcolm : I agree with you, and I am sure David can give you plenty of examples of when a customer comes into a work-out unit with us. When we are looking at the total circumstances of the loan we can arrange structures that say, 'This situation is either temporary or it is a cash flow situation. It would not make sense to increase the amount of interest charged on the loan or to require repayments that could not be repaid if those are going to put the business into a default situation.' The interests, in that sense, are aligned for that. We will, if it is a work-out situation where it requires to be rehabilitated back to the line, give interest rate reductions. We do not automatically charge default interest when we have an event of default; we do allow work-out periods before we do that.

Mr Lee : There are a number of options that you can have for a customer. It could be that we maintain the existing margin. We could look to increase it, as you have just said. We can look at the terms of the facility, in terms of the covenants that they have. We can look at repayment holidays for them. In some cases, we will actually say that we will stop charging interest. If it gives us an outcome that is better than insolvency, we would look at those sorts of options for a customer.

We have implemented those sorts of structures in the Westpac Group. There is no point in us putting the customer onto an interest rate that is going to cause them to run out of cash and then have to appoint an administrator. It is not in our interests. If the customer goes into administration, we know what the outcome will be; whereas if we give the customer options in terms of what they can do to resolve their financial difficulties, we normally get a better outcome.

Mr LAUNDY: This is my last point and it is more of a statement. From the evidence that has been presented to this committee, it almost looks as though the increase in margin has been aimed to mop up the excess in cash flow. I would much rather loans documentation that means that if there is an issue, if it does have to move from the good bank to the bad bank at some stage, that instead of it being sucked up in interest—and what has to be, has to be—excess capacity gets aimed at reducing the face value of the loan.

Ms OWENS: I am not sure that what you are suggesting will work. I want to talk about competition in that circumstance. If the bank was charging a default interest rate that was higher than the rest of the financial market would charge, how easy would it be for one business to move to another bank? To what extent can competition solve a circumstance where you might be doing what Mr Laundy says you might be doing?

Mr Malcolm : Competition is healthy in the market now and it has been in business lending. There is strong competition for lending in business. Obviously, once you get into a distressed situation and the business is underperforming, it becomes harder to refinance. That is a truism.

Ms OWENS: In which case, the price of that risk will go up. That is life.

Mr Malcolm : That is right.

Ms OWENS: But if you overprice that, to what extent can a business move?

Mr Malcolm : They can and do move. I was just going to say that in our work-out group, while we come in with an intention to try and rehabilitate as many customers as we possibly can, we do find that sometimes, for reasons of exactly that—where we have put up the credit margin or we have changed the conditions under which we have assessed the loan—someone else in the market will assess it in a different way and the customers can and do refinance. It may just be our assessment; we may be conservative and someone will take a different view of the asset and the customer. Relationships at a banker-to-customer level can break down and the customer may want to move, and they do refinance. I think somewhere in the vicinity of 20 to 30 per cent of customers that come into our work-out group actually refinance out to another institution. So even for a stressed account it does exist.

Ms OWENS: So cash flow and history of paying on time will trump LVR?

Mr Malcolm : Yes, it will.

Mr RUDDOCK: I do not know this organisation: Australian banking. Is it another competitor institution?

Mr Malcolm : I suspect that is the Australian Bankers Association.

Mr RUDDOCK: Chief Risk Officer, Australian Banking.

Mr Malcolm : That is my title.

Mr RUDDOCK: I was just wondering what this other organisation was. Is it the Australian arm of Westpac?

Mr Malcolm : That is right.

Mr RUDDOCK: I just wanted to find out whether you were speaking for other institutions. You are just speaking for Westpac?

Mr Malcolm : I am just speaking for the Westpac Group.

Mr RUDDOCK: So you do not consider changes to legislation or the self-regulatory regime are necessary for Westpac—or are you asserting that there is no element of Australian banking that might require legislation or a self-regulatory regime? Are you speaking for them all?

Mr Malcolm : No, I am speaking for Westpac. I am speaking for our position.

Mr RUDDOCK: But Westpac are not vouching for others, are they?

Mr Malcolm : No.

Mr RUDDOCK: I just want to be certain.

Mr Malcolm : Yes.

Mr RUDDOCK: If we were of the view that others required some self-regulation or legislation to manage part of what we might regard as their errant behaviour and so on, you would not be opposed to that if it maintained confidence in banking and the four pillars policy, would you?

Mr Malcolm : I did also say that there is always room for improvement and that we are happy to work with the industry and with legislators to improve all the time. There have been a lot of changes in regulation, and I think that that is not a bad thing. It has to evolve. It has to address the situation that is in the market today and for the future. So we made submissions to the financial services inquiry. We participated fully in developing standards, and we work with the ABA to advocate for the industry. We think that the current balance is pretty good, but we think that there is always room for improvement, so we are not ruling that out.

Mr RUDDOCK: For instance, one of the matters that concern me is that the Code of Banking Practice only really goes to individual customers or 'small business'. I assume that means that you take the view that every other business that cannot be defined as small has the same bargaining power as, say, Westfield in dealing with Westpac and trying to negotiate variations in terms and conditions of loans, for instance.

Mr Malcolm : We think that the current level is sufficient and has the right balance. We think that small businesses need more protection under this, and we think that the levels that they are afforded—the Financial Ombudsman Service, for example—at their level deal with the right size of customer to deal with that fairly and efficiently. If we start including that for broader, more well-resourced companies then I think that could get clogged and decrease the efficiency of that organisation. We will from time to time agree to hear matters outside of their limits where we think it is warranted. We have gone to FOS for matters that are above their limit where that has been appropriate, or where we have thought that is appropriate and the customer has agreed.

Mr RUDDOCK: What proportion of standard-form contracts for loans would Westpac agree to vary?

Mr Malcolm : I do not know the answer.

Mr RUDDOCK: Fifty per cent? Could I come along and say, 'Look, I'm not happy with the valuation requirements that you have for this loan, and I'd like to vary them'?

Mr Malcolm : If you talk about negotiations of terms of loans then every loan is negotiable.

Mr RUDDOCK: Every loan is negotiable?

Mr Malcolm : We negotiate on price.

Mr RUDDOCK: So 50 per cent would be varied from standard-form contracts, would they?

Mr Malcolm : No, I did not say that. I said that there are terms within the loans that are negotiable for things like price.

Mr RUDDOCK: What proportion do you think would be varied from standard forms?

Mr Malcolm : I do not know the answer to that. I am sorry.

Mr RUDDOCK: You might get that for me.

Mr Malcolm : Okay, I will try.

Mr RUDDOCK: I suspect it is probably less than one per cent. We will see if I am right.

Mr Malcolm : If you asked how many had changed their interest rate, it might be.

Mr RUDDOCK: I will leave it to my colleagues. I just think that some of those things, given the evidence that we are receiving, may well need to be looked at. If there are cogent arguments that we ought to be hearing from the industry as a whole, it would be useful to know what they are.

Mr Malcolm : Things like covenants and pricing are very regularly negotiated. From a prudential perspective, if you have 1.2 million customers and 1.2 million different forms of agreement it becomes very difficult to understand where your risks are. That is the reason why we try and keep it as standardised as possible. If the standard terms have been checked for fairness, efficiency, legality and compliance, you are lending in a safe way. But you can vary terms—

Mr RUDDOCK: They are standard forms for fairness, not advantage?

Mr Malcolm : As I said, we can negotiate terms such as price. How many deals are negotiated, particularly in the commercial space, on price? Talk to some of our frontline bankers and they will say every one of them.

Senator WILLIAMS: You have got receivers in eight farms. I had a terrible experience where one particular bank sent receivers into a family farm. The farmers harvested the wheat and then they left. And the place was left in a mess. Sheep were flyblown. Sheep were dying when they sent them off to the saleyards. The place got covered in weeds. I learnt then that it is not a good thing to send receivers into family farms because the receivers have no idea how to run a farm. When you send receivers into these farms, do you pay particular attention that they have good knowledge on how to look after the animals and the land?

Mr Malcolm : It is our last resort to send a receiver into a farm. We would always want to work with the farmer themselves.

Senator WILLIAMS: Good idea.

Mr Malcolm : Before we would appoint a receiver, we would always go through a farm mediation process. We try to work with customers beforehand because of the very risks that you have outlined there. We are part of the community. Our bankers in rural areas are part of the community. They know and deal with the farmers every day—and they are small communities. We want to be proud of our behaviour as well as our track record in that. Where we do appoint a receiver, sometimes we will send farmers in for precisely the things that you are talking about. If the farmers are incapable or unwilling to manage the farm themselves, we will always try to use capable farm managers.

Senator WILLIAMS: It is okay if you go into a corporate farm—like McGrathNicol went into Cubbie Station—because the management is retained in a corporate farm. But with a family farm, if you send in receivers and kick the farmers off, you lose your farm management, and there the problem arises. I just want to bring that to your attention.

Mr Malcolm : Thank you for that. We share your concern and we would always try and do that.

CHAIR: On page 16 of your submission you talk about dispute resolution and indicate your support for FOS. Does Westpac ever challenge the decisions of FOS?

Mr Malcolm : I will take that on notice, but I do not believe we have ever disputed a FOS dispute. I do not know that for a fact because I have not looked at it.

Mr Lee : I have got some details in terms of complaints that we have had. There have been 11 in the last 12 months. Four were resolved in favour of the borrower and we paid compensation of $300,000 to those borrowers. But there was none that we challenged in terms of taking it to a court or something like that.

CHAIR: You have indicated that you are comfortable with the current remit of FOS and you would not support increasing the scope of their involvement. If you are a residential consumer for a home mortgage, it could very easily exceed $500,000 in the current market, particularly here in Sydney. In terms of residential and, in particular, commercial loans, which is what we are looking at here for a small business, where would the limit be? I am happy for you to take that on notice. You just said that we are now going to be including so many people we are clogging up the system.

Mr Malcolm : I will take it on notice, but I would say that we support the current limit.

CHAIR: It has been put to us at the moment that, where a bank has any suspicion about the performance of a loan, you can call in a forensic accountant or you can get a valuation done to understand whether the market has changed and whether the value of the asset has changed. There is absolutely no downside risk for the bank, because, if the books check out okay and if the value checks out okay, you are happy and you have not had to pay for anything and you continue on as normal. But if there is a problem, quite often it is related to cash flow, and the very first thing you have done is actually caused the consumer to have to pay for something that they did not want, and quite often it starts to materially impact on their cash flow. If the onus was on the bank to actually absorb the cost of those initial appointments of a forensic accountant or a valuation, where there has not been a monetary breach—so they are up-to-date with progress on a building project and capitalisation of interest or they are meeting all their payments—would that have any unintended consequences?

Mr Malcolm : There is no incentive for us to send in an investigative accountant if there are no issues there. I try and explain our review process, because I think it is important to understand that when it is working smoothly there is no need for an investigative accountant, and we certainly would not want to impose one if there are no issues going on. We are required to do an annual review of our customers as part of our prudential obligations under APRA. We look at how the business is performing, and one of those non-financial covenants that we get up-front is the provision of financial information, so that we can see what the customer is doing. Normally, we would sit around and say, 'What's the business doing?' We can ask questions. If there are signs of distress or we can see signs of problems occurring, we will sometimes speak with the customer, and, with the customer's engagement, ask to have an investigative accountant to come in and do further work, where there are signs of distress.

It is the same with a valuation. If there has been no change in market values—Sydney house prices have gone up—there would be no need for us to ask for a fresh valuation if we got one last year. We get one every three years, generally, but if there has been no change, we will waive that based on just market information. So, again, we do not want to impose extra costs on our customers for the sake of it. If there is distress and there is evidence that we would like to investigate further, we will work with the customer to see whether an investigative accountant should go in further. Do you want to talk about the cost allocation?

Mr Lee : Normally there is a trigger for us to appoint an investigative accountant, as David just said. There is a commercial negotiation that goes with the customer in terms of the appointment of an investigative accountant, because it covers their whole facility. Normally they will be asking us to consider things like waiving breaches of covenants. There may be payments that they cannot make, in terms of principal payments; they may have a facility that is expiring; or their company may be in financial distress, in terms of its cash flows, so they may need additional borrowings. Also, if the company is in financial distress they normally have other priorities they are looking at and they do not have the ability to produce financial statements on a regular basis. The bank needs certain information to consider their requests, if they put requests to us. One of the commercial negotiations is the appointment of an investigative accountant. Under our agreement, if there is a breach or a default, then the customer pays for the investigative accountant.

CHAIR: In terms of written notification, we have had a number of people come to us where facilities have been due to roll over and they have sought an indication from the bank as to whether the bank is happy to continue. There has been verbal indication that, yes, that is going to occur. It gets within a time frame where it is probably unrealistic for them to go out and seek an alternative source of credit, and then a decision is taken not to continue and that often triggers some of the unhappy tales that we have heard.

Does Westpac have an internal policy about any undertaking from whatever level in the bank to a client that a rollover is going to be considered favourably? Do you have a policy that it has to be in writing? If you give that three months out, for example, and then two months out you have a change of heart, is there any internal policy that says, 'Well, three months is a reasonable time frame to refinance. We've given a commitment in writing; we will honour that and work with the customer,' or can you change your mind the night before?

Mr Malcolm : Certainly, if we are seeking not to roll over, we give sufficient notice to allow time to refinance. I think that would be our standard operating practice. Again, I cannot count for verbal assurances that might have been given. That does happen—I acknowledge that that would happen. A banker at the front line would say, 'Yep, I'm fine with that,' and then when they actually present it to credit either they are surprised or something comes up in the review and for one reason or another that is declined. We say, 'Actually, we think this needs to be worked out.'

So it can happen, and in that case I think that if we said we were going to roll over that we would not turn around and say, 'You've got one week to refinance this.' We would give sufficient notice and ability for time to refinance or to seek finance elsewhere. Without putting a hard-and-fast rule, because it is always a case-by-case type of—

Mr RUDDOCK: So if the relationship manager said, 'It's fine—don't worry,' you may not honour that?

Mr Malcolm : Again, verbal agreements can be binding. It depends on what is said and how it is said—

Mr RUDDOCK: You know what happened to Les Irwin, don't you?

Mr Malcolm : To who?

Mr RUDDOCK: Les Irwin. He was the manager of the Commonwealth Bank at Blacktown who had to personally guarantee Frank Lowy's first loan after he approved it.

Mr Malcolm : Ah, yes!

Mr RUDDOCK: I thought that would be written into your institutional memory!

CHAIR: Folklore!

Senator WILLIAMS: Did he get a promotion for it?

Mr RUDDOCK: He got a seat in federal parliament!

Senator WILLIAMS: Oh, that is all right! Is that a promotion or a demotion?

Mr Malcolm : It may have been before my time. David might remember it—

Mr Lee : No!

Mr Malcolm : Again, whether it is verbal or not we would want to give sufficient notice and time for a customer to refinance if we have made that decision. Do we honour verbal agreements? Well, if they are not authorised to make that agreement then we would have to work with the customer.

CHAIR: I guess that the point I am trying to drive to here is how is the consumer protected? My background is in aviation. I look at CASA's role as the regulator. We might have the owner or the holder of the air operator's certificate who sits and says, with the best of intentions, 'We're going to look after our passengers. We're going to do this and we're going to do that.' It is not good enough. They actually have to document it and have procedures and an operating manual that says how they will mitigate the risk for the passengers, to ensure the safe operation. And they then have to follow those or they lose their ability to operate an airline.

What strikes me is that there are lots of good intentions and there is lots of reliance on codes of practice, but at the end of the day there appears to be very little that protects the consumer from the advice of a front-line relationship manager who says, 'It will all be good.' Then a credit management group within the bank, which might be working through a backlog, suddenly picks it up two weeks out from the rollover and says, 'Not on my life!', which then leaves the consumer incredibly exposed. How do we make that process more robust?

Mr Malcolm : It is a really good point. We definitely do a lot of monitoring of code of conduct and also procedures. We actually have to have controls in place to ensure that those kinds of things happen. We do monitor our people and the actions that they take.

If there is a case where a banker at the front line has made a promise without authorisation, that can have consequences for that banker and it will obviously have consequences for us in the relationship with the customer, and we will take that into consideration. We will make a reasonable effort. It is completely understandable if the customer says, 'Oh, your loan is going to roll over—your banker said that. You gave me no notice.' We would have to take that into consideration, that the banker has given them that information.

CHAIR: For example, a client says, 'My facility is going to expire in five months time,' and the ABA says, 'We think three months is a reasonable period for someone to go and refinance'.' What if there was a recommendation that said the code of conduct should be that if the consumer has made a valid application for a rollover, the bank must give them a decision at least three months out? Would it be an unfair imposition on the banking sector to put those kinds of timeframes not in regulation or legislation, but in the code? If that failed, perhaps we would have to legislate. Would that kind of timeframe be viable for the bank? It strikes me that that would give consumers the incentive to formally apply and consider their business and their credit, but it would also place the onus on the bank to respond in a given timeframe, and, if they did not, then the code should say that any outcome should be in the favour of the client because the bank has not met its obligation under the code.

Mr Malcolm : I think reasonable notice to find a new facility is a good concept, and I would certainly be happy to work with the ABA in a review of the code to say that that is a reasonable amount of time. Again, I will probably have to take that on notice to say that we are happy to work with the ABA and industry to work out what is a reasonable amount of time. Three months sounds reasonable to me sitting here today, but I would have to see what the other views are and work with government and industry to come up with a reasonable approach to that.

Mr LAUNDY: I gave you advice earlier, and now I am going to ask your advice. It is a question out of left field. I believe we sit potentially at one of the most exciting times agriculturally in our country's history. I see liquidity as the real Achilles heel to taking advantage of the opportunities that things such as the Chinese Free Trade Agreement present the agribusiness sector. Given the risk profile and the nature of the farming sector, and that we have such a concentrated banking system—through no fault of your own—would you consider there to be a role for government in working with you, as has happened in the US through Farmer Mac, to unlock this liquidity and potential? Keeping in mind—and I do not know how much you know of Farmer Mac—that the banks work there to effectively roll their loan books into it to unlock competition and credit availability in the sector. Obviously, its cousin, Freddy Mac, is a lot better known, but Farmer Mac has actually been extremely successful and suits the risk profile of that sector. I want your opinion on whether we as a country can do it with banks alone, or, given the nature and the risk profile of the business, does government have a role to play in liquidity in the market?

Mr Malcolm : First of all, I will start by saying that I share your enthusiasm for the future of agriculture, and I think that is certainly something that government should be encouraging. From a risk profile point of view, one thing I would caution is that, because of the nature of agriculture—the volatility of cash flows, the dependence on seasons and rainfall and all of those kinds of things—it is not sensible to overgear volatile industries. We do have relatively lowly-geared farms in Australia, and that is a good thing. My view is that the reason we have got only eight farm customers in receivership is that we have been relatively conservative on giving customers loans that they can afford. I will say that how we can help agriculture expand using capital is an idea worth exploring. I would be cautious about the role of government going into particular industries and doing it through giving farmers more loans—you did mention Freddie Mac and Fannie Mae. Whenever you do that you create distortions in the market around allocation of resources. If you try to pick winners—and I think we should support agriculture more generally—how would you actually go about selecting farms or ventures in order to form that help? If you do it by helping banks help customers by providing some sort of government guarantee, then that can come with some moral hazard. Are you lending to the customer because it is good farm or are you lending to the customer because it is guaranteed by the government? I think it is an idea worth exploring, and I am happy to talk to you about it

Mr LAUNDY: Take it offline. I have a paper I would like you to have a look at.

Mr Malcolm : Sure, I am happy to do that.

CHAIR: Gentlemen, thank you for your submission and for your evidence today. You have undertaken to take some things on notice. If we could have those back to the committee by 27 November. Thank you to broadcasting and to the committee secretariat.

Committee adjourned at 16:31