Insights into ASIC’s Responsible Lending Hearings – Part 3

Insights from ASIC's Responsible Lending Hearings
Part 3


Did you say 'discretionary'?

The term 'discretionary' is not a precise term in the context of expenses. I have had conversations over the past year go awry when discussing expenses simply because of misunderstandings associated with this term. The use of the term discretionary in the Household Expenditure Measure (HEM) raises some interesting considerations.

Overseas holidays, wagyu steaks, and Versace suits are not considered discretionary in the context of HEM.

Let's clear it up...

In its common use, a person's 'discretionary expenses' refer to the amount that is considered non-essential and could be foregone.

The term 'discretionary' is also used in the context of the HEM. The expense categories in the Household Expenditure Survey are allocated by the Melbourne Institute academics for their analysis into a number of different HEM categories:

  • Basic (further divided into 'Absolute Basic' and 'Discretionary Basic')
  • Non Basic
  • Excluded

The HEM is then calculated by adding the median of the survey responses for Absolute Basics to the 25th percentile of the Discretionary Basics. 'Non Basic' expenses (which include overseas holidays) are NOT included in the HEM calculation as they are considered 'luxury' expenditures which can easily be done without.

Herein lies the problem.

Discretionary or 'Non Basic'

Overseas holidays are typically thought of as discretionary (i.e. non-essential), but for HEM purposes they are NOT 'Discretionary Basic', but are 'Non Basic'.

Discretionary or 'Absolute Basic'

Wagyu steaks at a cost of $100 are typically thought of as discretionary (i.e. non-essential), but for HEM purposes they are NOT 'Discretionary Basic', but are 'Absolute Basic'.

Does it matter?

What if I consider a consumer's $5000 overseas holiday as Discretionary Basic and include it in their living expenses for HEM comparison?

  • Doing this might mask the fact that the customer's 'Absolute Basic' and 'Discretionary Basic' declared expenses are lower than HEM. A lender that compares the declared expenses to HEM to check plausibility, the higher number (declared expenses) would be used for affordability calculations. In the opinion of the Melbourne Institute, the overseas holiday should be excluded from HEM as a Non Basic item. The impact is that in some situations, the available credit would be lower than if the overseas holiday was excluded.

What if I consider a consumer's $100 Wagyu steak as non-essential and exclude it in their living expenses for HEM comparison?

"I may eat wagyu beef every day washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare" – Federal Court Justice Nye Perram

  • Doing this might mask the fact that the customer's declared expenses are higher than HEM. When compared to HEM to check plausibility, the higher number (HEM) would be used for affordability calculations. This could make the total available credit available to the customer higher than if the Wagyu had been included. Is this ok? The opinion of Federal Court Justice Nye Perram probably suggests yes!

Over-reporting the percentage of loans that were under HEM

Note that in this scenario, the consumer's declared expenses would have been lower than the HEM because of the exclusion. Where any decision excludes some 'lifestyle' expenses (that are also considered 'Basic' in HEM), a percentage of these will artificially inflate the percentage of a lender's incoming credit applications that are reported as being lower than HEM.

A similar effect might be observed where other HEM Basic expenses are excluded deliberately or inadvertently. Some large expenses that might cause an effect are car & motorcycle purchases, whitegoods, furniture if not included in the declared expenses. These are frequently excluded in the way the questions are asked of the borrower ("What are your ongoing, recurring living expenses?" for example.)

Questions

The Commissioners have continued to show a particular interest in the percentage of applications that result in declared expenses being lower than HEM. What is an appropriate number?

Yet another space to watch ...

Shane Rigby
CEO - LIXI Limited
26th August 2019

Last Updated: 26th August 2019

See also: Part 1 & Part 2.