The Financial Services Royal Commission has been a public relations disaster for the industry.
Australia’s big four banks – NAB (ASX: NAB), Commonwealth Bank (ASX: CBA), ANZ (ASX: ANZ) and Westpac (ASX: WBC) – and wealth manager AMP (ASX: AMP) no doubt wish the government had held firm against calls for such a Royal Commission.
Putting aside all the bad actions (and actors) that have been revealed, though, one recent session raised an important issue for parents everywhere: should you guarantee a loan taken out by your children?
This question came to the forefront earlier this week when a mother who had guaranteed a business loan taken out by her daughter appeared before the Commission. Unfortunately, the business didn’t succeed and Westpac, the lender in question, called in the guarantee and attempted to seize and sell the mother’s house to satisfy the outstanding loan.
The Financial Ombudsman Service found nothing wrong with Westpac’s actions. It was only when the mother, with the help of Legal Aid, essentially pleaded for mercy from Westpac that the bank relented and allowed her to stay in the home – albeit now owned by the bank – for the rest of her life.
That the mother is disabled and may not have been fully aware of the possible consequences if the guarantee was subsequently called in is one issue. And whether the Westpac representative should have taken more care to ensure she was – and refused to accept the guarantee if she wasn’t – is another.
But should parents be discouraged from guaranteeing loans for their children and/ or regulations tightened to require the banks undertake more due diligence and ensure debtors fully understand the terms and conditions of loans and associated guarantees?
Unfortunately, there aren’t any easy answers here.
It’s only natural that a parent would want to help their child succeed and so the mother in question is unlikely to be the last to be willing to provide such a guarantee.
And the reason the banks accept a house as collateral is that the house’s value is highly likely to be sufficient to satisfy any guarantee – and relatively easy to seize and sell if necessary.
Moreover, using houses as collateral means borrowers pay much lower interest rates than they otherwise would without such a guarantee.
Without this collateral, interest rates paid by small businesses would be much higher, the supply of capital to them much reduced, and Australia as a whole likely much worse off.
But I don’t think it’s as simple as saying to debtors (and their guarantors): “caveat emptor”.
For public relations reasons as much as being proper stewards of bank shareholders’ capital, perhaps bankers should spend more time ensuring borrowers (and their guarantors) fully understand the consequences if the loan goes sour.
And ideally, if the banker is concerned they don’t, then he or she should refuse to grant the loan and accept the guarantee.
(Of course, that raises the question of the banker’s incentives and whether these incentives are properly structured – but that’s a topic for another day).
For their part, parents need to try to put love aside and be more “businesslike” when considering guaranteeing a child’s loan. Ask yourself whether you can satisfy the guarantee without it leading to significant reductions in your standard of living – such as having your home seized and sold – at a time in life when recovering from such setbacks is harder than when you were younger.
As for children taking out loans guaranteed by their parents, I’d suggest you take a more conservative view of your business’s chances of success. Understand the consequences if your business fails, not only for you but for your likely elderly parents who have guaranteed your loan.