Ombudsman calls for government guarantees for SMEs

The report reads: “Limited competition — and risk-weighted appetite focused on real estate — limits lending to SMEs. The market failure arises where SMEs have limited collateral, other than a family home, to provide security for a loan. While private equity is an alternative source of capital, the majority of investors seek a rapid return. Private equity investors attempt to implement managerial and operational changes to improve the company’s performance, before selling it for a profit…

“Alternate lenders do not require bricks-and-mortar security but do charge significantly higher interest rates, offer low amounts over short terms and may seek a personal guarantee… These finance solutions might provide a useful, short-term stopgap but cannot provide patient capital for growth over time.”

The Ombudsman’s report highlighted data from MoneyQuest brokers which showed that less than 22.5 per cent of enquiries received result in an approved referral.

“The rate of rejection before application reflects banks move to automated processes using check lists to assess the initial enquiry,” the report reads.

It goes on to suggest that brokers therefore play a key part in helping SMEs access finance, saying: “As SMEs typically have less documentation and shorter financial histories than large corporations, they often fail at this first hurdle… The report shows that high-growth employing firms represent approximately 10.5 per cent of the SME population. A successful loan application by these SMEs will always require tailored assessment.”

The report says that, in order to address market failure, there needs to be “an increase in the supply of capital in Australia for SME lending and increased competition between financial providers”.

While the Ombudsman noted that state governments are increasingly taking the initiative to support their SMEs with access to capital, she said that “the result will be a patchwork of offerings”.

“Without a national solution, the capacity to access affordable capital will be at least partially dependent on where a business is located,” Ms Carnell wrote.

As such, the Ombudsman has suggested that a new Business Growth Fund be established by the private sector to provide a national solution (similar to the growth fund in the UK), which could offer both debt (loans) and equity (investment) to support SME growth.

Ms Carnell has suggested that an initial pool of $1.5 billion in capital could be sourced from the Future Fund, superannuation funds and banks.

In this recommendation, businesses would reportedly be able to apply for amounts between $250,000 and $5 million, with terms up to seven years, secured against the business and owner/director guarantees.

SMEs that receive funding would also be provided with mentoring, coaching and access to a talent pool of expert staff to maximise the benefits of the patient capital investment.

The fund would operate commercially, independent of government, and would most likely use technology to create a “low-cost delivery model” and an automated triage platform that would require SMEs to lodge key documents (such as business plans and cash flow projections) for assessment. The credibility of the application would then be undertaken face-to-face.

Loan and investment decisions would then be made by professional managers independent of government, with performance assessed on “a fully commercial basis according to private sector funding models, against average annual rates of return”.

Ms Carnell added that an independent investment committee would be responsible for setting the overall parameters for lending and investments, and the government’s only role would be the initial promotion of the partnership construct and to assist clearance of possible regulatory barriers.

The report also calls for the government to create an Australian Government Guarantee Scheme (GGS) that would partially guarantee SMEs:

• who do not qualify for bank funding because they do not have a real estate security;
• where the loan required is for more than three years (the maximum limit to which banks tend to lend); and
• when the SME operates in a sector for which the banks have debt appetite restrictions.

A guarantee would then be accessible to members of the scheme with eligibility limited to banks. This would ensure the guarantee is issued within existing prudential regulations for lending.

The federal government would also establish a Capital Enhancement Fund to provide Tier 2 capital instruments to banks to enable a “capital build” by providing access to a new pool of capital.

The capital would reportedly “address the funding differential that is known to exist between Tier 1 banks and other banks”, which the RBA states is around 20 to 40 basis points (or worth $1.9 billion annually to the major banks).

Other recommendations include:

• APRA moving from the one-size-fits-all model and allowing regulated institutions to apply risk weightings to specific risk factors.
• The Australian Financial Security Authority (AFSA) overhauling the Personal Property Security Register — at a minimum the public interface — to make it fit for purpose so a non-legally trained individual can accurately register title to best utilise assets as security against lending.
• SMEs working with their trusted advisers (including accountants, lawyers, brokers, business advisers, etc) to get their business finance-ready.
• The government implementing and promoting government initiatives of comprehensive credit reporting and the consumer data right in banking — part of Open Banking — in line with the government’s schedule and the benefits “widely promoted to SMEs”.
• The ASBFEO developing a short guide on financial providers, the range of financial products available and what stage of a business cycle each product is designed to fit. The guide will be distributed through the networks of SME advocates and publicised through social media.

Several industry players have welcomed the report, with Scottish Pacific’s chief customer officer, Ben Cutler, drawing parallels between the report’s findings and the specialist lender’s own SME Growth Index research.

Mr Cutler said: “It’s great for business owners to have wide funding choices and any effort the Ombudsman makes to put more options in front of SMEs, such as an SME Guide to Financial Products, is very welcome.”

Likewise, the CEO of the Institute of Public Accountants (IPA), Andrew Conway, welcomed the recommendations, saying that they demonstrated “the plight of SMEs who struggle to grow their businesses due to the lack of adequate capital, finance and support”.

Mr Conway added that Australia was “one of the only countries in the developed world without [a loan guarantee] scheme”, which he said would “help increase the availability of much-needed, affordable loan finance to the small business sector”.

Mr Conway claimed that “a limited state-backed guarantee would encourage banks and other commercial lenders to increase loan finance available to small business at affordable rates”.

“Access to responsible and affordable finance will help many small businesses reinvest in their businesses and help create new ideas, new capacity and new jobs,” Mr Conway said.

[Related: Royal commission to focus on credit to SMEs]