‘Insufficient attention’ being paid to improving SME loan risks

The commission’s sizeable report looked at both home loan finance and the provision of small and medium-sized businesses, offering a range of recommendations for both.

Looking at small and medium enterprise (SME) finance, the commission’s draft report stated that access to debt finance is “not a problem for most small businesses that are confident to apply”, highlighting ABS figures that nearly 90 per cent of SMEs who applied for debt finance in 2015–16 were successful.

However, it warned that there was “insufficient attention being paid to opportunities to improve weighting of SME loan risks and lower smaller banks’ cost of capital”, among other issues.

“These failings have the capacity to prevent loans being made or cost borrowers significant sums,” the draft report noted.

The PC went on to highlight the following “issues” with the financing of SMEs:

• SMEs pay relatively more for their finance. Interest rates for small business loans and overdrafts secured by residential property are between 1 per cent and 4 per cent higher than the interest rates applying to residential housing, with the higher price of unsecured SME finance due to “the higher risk lenders place on lending to small business and the higher capital provisions required of lenders by APRA”.

• The reliance on real estate as collateral. A significant amount of lending to SMEs is secured by real estate, often a residence — which means that some businesses have to rely on the owner’s house or “rely on more expensive unsecured finance”.

• The large banks dominate SME lending. Most business finance, particularly for small business, is obtained through the four major banks (accounting for more than 80 per cent of loans less than $2 million in 2017 and in excess of their share of large business loans and housing loans), but there are “ emerging innovative lenders entering the SME lending market.

• The terms and conditions placed on SME loans. The PC highlighted that there are concerns as to “the adequacy of the protections and practices” around lending to small business that have resulted in “complex one-sided contracts that have enabled lenders to make unilateral changes to the terms and conditions of the loans, including credit renewal”.

As such, the PC is asking for stakeholders to provide responses to a draft recommendation to change the standardised risk weightings for SME lending.

The recommendation suggests that instead of applying a single risk weight to all SME lending not secured by a residence, the Australian Prudential Regulation Authority (APRA) should provide a “broader schedule of risk weights” in its Prudential Standard (APS 112).

This, it argued, should take into account the risk profile and the type of lending (such as the value of the loans made to an individual business and alternative forms of loan security including commercial property and differing loan-to-value ratios on this security) to better reflect the Basel Committee’s standardised risk weightings.

“International best practice should be closely considered,” the PC stated.

The recommendation continues: “In light of apparent major improvements in the use of artificial intelligence algorithms and data collection via the new payments platform, APRA should consider proposals by ADIs for variations to the standardised risk assessment for business lending, based on their data and risk management systems.”

The PC went on to note that as some cloud-based accountancy service providers, such as Xero, can provide SMEs with access to lenders on the platform — and SMEs seeking finance can provide lenders with access to their business data and real-time transaction data — there could be an opportunity to improve this information flow and thus provide better risk profiles.

“Having access to wide-ranging historical and real-time transaction data provides improved information for lenders to better determine a borrower’s level of risk,” the draft report reads. “The commission was told that invoice lending and lending against cash flow can be provided to borrowers at lower rates where lenders have access to such information. For the SME, access to real-time transaction data will also assist them in managing their business.”

It therefore suggests that to provide for improved data access, the proposed Open Banking system should be implemented to “ensure that small business have the full suite of rights, as consumers, to access and use digital data”.

Those wishing to provide a written submission to the PC on the matters listed in the draft report are asked to do so “preferably in electronic format” by 20 March 2018 and/or by attending a public hearing.

Public hearings for this inquiry will be held at the Wesley Conference Centre on Pitt Street, Sydney, on 28 February and 1 March 2018, and at the Rattigan Rooms on Collins Street, Melbourne, on 5–6 March 2018.

The final report will be prepared after further submissions have been received and public hearings have been held and will be forwarded to the Australian government by 1 July 2018.

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