Productivity Commission lauds broker role in SME finance

The report has underscored the importance of the business finance and loan broker channel in connecting SME borrowers and lenders, adding that they can assist SMEs with broadening their awareness of available lending options, as well as build trust by educating clients about whether lenders are “reputable”.

“Brokers help SMEs to understand the available lending options. By connecting borrowers to lenders, brokers can play an important education role, particularly for those SME customers that do not have the time or inclination to undertake detailed market research on their own,” the report said.

“These SMEs may have difficulties in keeping up to date on lending market changes and emerging options, but brokers are expected to have current market knowledge and participate in ongoing training to stay informed about new lenders and products.”

Lenders report mixed response to brokers

Nonetheless, the report said that SME lenders have reported mixed experiences with broker-referred customers.

The commission said that it has heard conflicting feedback that brokers have tended to refer more mature (and therefore lower-risk) business customers, broker-referred customers have higher default rates, and that there is no difference in the riskiness of customers based on their approach channel.

The report further explained that Australia’s broker market is relatively fragmented, with “blurred boundaries” between personal and business brokering, and as such, there is no single estimate of market size.

Referring to figures from the Commercial & Asset Finance Brokers Association of Australia (CAFBA) and the Mortgage and Finance Association of Australia (MFAA), the report said: “Previous research identified more than 11,000 commercial brokers operating in Australia in 2020… though business lending can also be facilitated by other brokers.

“For example, another survey found that over 4,500 mortgage brokers also wrote commercial loans in 2020, and reported that mortgage brokers are increasingly writing commercial loans as they seek to diversify their portfolios.”

SMEs prefer debt over equity

The study also focused on SME preferences for finance, and found that debt finance is the more common option sought by SMEs requiring external finance.

In 2018-19, about 15 per cent of SMEs applied for debt finance compared to only 5 per cent applying for equity finance, the report said.

Larger SMEs had higher application rates than smaller SMEs, with 9 per cent of SMEs with less than $500,000 turnover applying for debt finance in 2018-19 compared to 27 per cent of SMEs with turnover between $10 million and $50 million.

SMEs operating in primary industries (agriculture and mining) had the highest application rates at 23 per cent, followed by SMEs in logistics and supply chain industries (18 per cent). Only 11 per cent of SMEs in knowledge service industries (including information, financial and professional services) applied for debt finance.

The majority of SMEs that sought debt finance in 2017-18 applied to banks (69 per cent).

As at April 2021, authorised deposit-taking institutions (which are mostly banks) had issued 91 per cent of the $423 billion of total outstanding lending to SMEs.

“Banks have traditionally concentrated on less-risky market segments, with much of their lending secured by property as collateral,” the report said.

“About half of all outstanding lending to small businesses in Australia is secured by residential property.”

Hurdles deterring SMEs from applying for finance

The majority of SMEs (84 per cent) that applied for debt finance in 2018-19 were successful.

However, some stakeholders have reported that SMEs face challenges in obtaining finance including the banks’ market dominance and their preference for lower-risk secured lending, which could deter SMEs lacking property assets from applying for finance.

“The data show that SMEs with more assets are more likely to apply for and obtain debt finance, but this also reflects that businesses requiring large asset bases (in certain industries, for instance) have greater need to fund these investments,” the report said.

Tech opening new doors

The commission observed that new SME lending opportunities have been created through the use of new technologies and data sources to improve risk assessment processes and lower the cost of SME credit decisions.

This includes the application of artificial intelligence and machine learning by lenders to large volumes of customer information to understand risk assessments. In addition, comprehensive credit reporting (CCR) has allowed business lenders to use the data to make credit decisions, while the Consumer Data Right (CDR) has provided borrowers with better access to their own banking data, which they may share with third parties, including brokers.

The report said: “While some SME owners worry about their access to finance, a surge of new lenders and products into the market appears to be rapidly changing the options for SMEs.

“Some of these options rely on emerging technologies that help lenders quickly assess the creditworthiness of SMEs. Combining new data sources with innovative analytical tools (such as artificial intelligence and machine learning) has given many lenders the information and confidence to lend to SMEs without the security of property.

“In other cases, lenders have taken a more traditional relationship-banking approach, providing tailored services that were once the hallmark of the banks.”

In addition, the commission addressed regulation, observing that it is “relatively light-handed” in the business-to-business lending space, which has allowed new players to enter the market.

Government initiatives to promote data sharing has helped provide lenders with timely information for credit assessments. For example, fintech lenders have been able to quickly approve modest, short-term SME loans, the report stated.

However, some lenders have suggested that the SME lending space could soon face new regulations as the SME sector begins to recover from the COVID-19 crisis.

Brokers key to educating on new options

Commenting on the report, Productivity Commissioner Catherine de Fontenay said that one in six SMEs seek finance every year to fund and grow their businesses.

“Traditional SME loans are usually secured by property. But spurred by new technology and new data, lenders now have more capacity and confidence to lend to SMEs using other forms of collateral or even lending unsecured,” she said.

Productivity Commissioner Malcolm Roberts said that there is now a much broader range of products available from traditional and new lenders, which could even allow some SMEs to borrow for the first time.

“SMEs may not be aware of all their lending options and may not feel confident about new options. Brokers can help match them with appropriate lending options,” he said.

“Finding the right product may be challenging, but the benefits can be significant.”

[Related: Major bank CEOs flag SME ‘pressure’]