RBA highlights SME finance ‘challenge’

Barriers to finance

The RBA assistant governor for financial markets told AFIA delegates that these challenges include the fact that lenders “reject a greater proportion of loan applications from smaller businesses” given that they “tend to be [viewed as being] riskier than large, established firms with a track record of profitability” and that lenders therefore typically “charge more to take on the additional risk associated with the loans that they provide”.

Mr Kent added that terms for SME loans “may also be more restrictive”.

“For instance, loans to small businesses may often be small relative to the size of the business, or require collateral or personal guarantees. Indeed, around 95 per cent of loans to SMEs are secured – compared with around 70 per cent for large business loans – and about half of small-business loans are secured by residential property,” he explained.

“Many small-business owners may not be well placed to provide sufficient home equity to secure a suitable loan,” Mr Kent continued.

“Small businesses generally have few viable alternatives for external finance outside of traditional intermediated finance. Unlike large businesses, it is too costly for them to raise funds directly from capital markets.”

As such, he highlighted that Australian small businesses have made “increasing use of non-traditional sources of finance in recent years, such as balance sheet lending and marketplace lending” (although this still accounted for less than 2 per cent of overall SME lending, according to 2018 data). 

The impact of COVID on SME finance 

Mr Kent said that while economic conditions are improving, “it has been a particularly tough year for small businesses” given that small businesses were twice as likely as large businesses to have reported declines of 50 per cent or more. He said that this was partly as many small businesses operate in industries such as cafes, restaurants, arts and recreation, which were most affected by movement restrictions. 

The RBA assistant governor did add, however, that despite predictions that SME lending would plummet during COVID-19, aggregate lending to SMEs had “little changed” since the onset of the pandemic. 

According to the central bank assistant governor, this could be due to “the reluctance of some businesses to take on more debt in a weaker and more uncertain economic environment” and the uptake of government and private-sector measures designed to support business cash flows.  

“This reduced the need for many businesses to access external finance, which is more expensive than a business’s own internal funds,” he said.

Mr Kent also welcomed that just 1 per cent of all SME loans remained on deferred repayments (down from 13 per cent in June 2020), and that modelling by large banks suggests that the risk of default for small businesses relative to large businesses did not change much in 2020.

In the second half of 2020, commitments for new SME loans increased to pre-pandemic levels, largely due to businesses borrowing funds for the purchase of property, and plant and equipment (consistent with the expansion of the Australian government’s instant asset tax write-off scheme).

Refinancing activity was also higher than pre-COVID, given reductions in interest rates.

Mr Kent told delegates that outstanding rates on variable rate loans to SMEs had, on average, declined by about 85 basis points since February last year, which corresponded with a decline in banks’ funding costs and lower interest rates on loans.

He continued: “I should emphasise, however, that pricing alone does not provide a complete picture on the availability of finance. Indeed, small businesses have reported that the price has not been the biggest impediment to accessing finance over the past few years. For instance, entrepreneurs in our small-business panels have noted that access to finance for start-ups is a challenge, banks often have substantial collateral requirements, and the process for getting finance is lengthy and onerous.” 

The assistant governor (financial markets) continued: “Another factor weighing on lending is a more cautious approach by banks in deciding whether to finance small businesses. Much of this has reflected the application of pre-existing lending standards in a weaker economic environment.  

“But lending standards have also been tightened. For example, banks have required a greater degree of verification of borrowers’ information, and banks have been more cautious about lending to new business customers and to the sectors hit hardest by the pandemic,” he stated, reflecting some of the arguments currently being made in regards to the need to remove responsible lending laws.

RBA to ‘pay close attention’ to SME finance

In closing, Mr Kent said: “The supply of finance remains tighter than before the pandemic, particularly for those businesses that were hit the hardest. While there are signs that conditions have started to improve a little recently, surveys of small businesses indicate that access to finance remains difficult.

“Even so, the policy responses have helped to cushion the impact of tighter access to credit. The cash rate cuts through 2020 and other initiatives to reduce banks’ funding costs have flowed through to lower interest rates on SME loans,” he said.

He later warned: “Nevertheless, business failures are expected to rise as some of the pandemic support measures are phased out.” 

Mr Kent concluded: “Overall, smaller businesses have suffered significantly from the economic hardship caused by the pandemic. A wide range of monetary, fiscal and private-sector measures have provided support. Indeed, many of those measures obviated the need for small businesses to take out additional debt over the past year. 

“While businesses’ confidence has improved markedly of late, a number of businesses, particularly smaller businesses, remain reluctant to take out new loans. Some of this reflects an economic outlook that, while improved, is still very uncertain. Also, access to finance for smaller businesses has been a longstanding challenge. 

“There are a range of policies in place to help support the supply of business credit as the economic recovery proceeds. Given the importance of small businesses to the economy, we will continue to pay close attention to their access to finance and their prospects more broadly.”

ASBFEO echoes concerns

The Australian Small Business and Family Enterprise Ombudsman Bruce Billson welcomed Mr Kent’s speech and further scrutiny of small business access to finance. 

“Finance is the oxygen of enterprise,” Mr Billson said. 

“Mr Kent’s comment that access to finance for small businesses has been a longstanding challenge and is now tighter than before the pandemic is correct. 

“I support Mr Kent’s plea to banks to take a different approach to small-business borrowers, given that even under the existing responsible lending laws, banks are not obliged to apply the same serviceability requirements to small businesses that need to be applied to households,” he said. 

“I also share Mr Kent’s concerns regarding the banks’ lengthy and onerous process to securing finance, including substantial collateral requirements.”

The new ASBFEO continued: “Of course we need to strike the right balance, but any move to loosen onerous restrictions on access to finance for small business would be positive. 

“The RBA has noted it expects business failures to rise as government support measures are phased out. This highlights the critical need for small businesses to have greater access to finance, to provide the cash flow necessary to get through the coming months. 

“Overall, we welcome the RBA’s acknowledgement of the important contribution the small-business sector makes to the economy as well as its efforts to continue to monitor small business access to finance and their prospects more broadly.” 

[Related: RLO repeal would reduce ‘policy creep’: CAFBA]