The parliamentary committee investigating the banks will consider whether to set a threshold for new protections for small business borrowers at $5 million of total loans rather than $3 million as preferred by the banks.
So-called "non-monetary default" clauses in loan contracts with SMEs transfer external risks to the customer by giving banks power to enter negotiations when, for example, the value of loan security falls as determined by a loan-to-valuation ratio.
Given about two-thirds of all small business loans are secured by residential property, these clauses will give banks the ability to default many small business borrowers if there is a crash in housing markets.
During sustained questioning of the big four bank CEOs on business lending by the House of Representatives standing committee on economics over the past week, the bank bosses said they hardly ever use the powers – but nevertheless want to restrict calls for them to be removed.
Kate Carnell, the small business ombudsman, said in a report published in February that the clauses should be removed for loans up to $5 million, which would cover 98 per cent of small business lending. The financial system inquiry by David Murray and the review of the banking industry's code of conduct by Phil Khoury also recommended lifting the definition of small business borrower to $5 million from its current level of $1 million.
But the big banks want the threshold set at total lending of less than $3 million. The committee chaired by Liberal MP David Coleman is expected to make a recommendation in its next report on where the limit should be set.
Ms Carnell says banks already put a premium on small business loans to take into account their higher risk and "can't have it both ways" by shifting all risk to the borrower in their contracts. She says breaching such conditions does not necessarily mean that a borrower cannot repay a loan in the short term.
But the banks say the clauses are important, not because they are used to default borrowers but to trigger a necessary conversation with customers, to help them avoid getting into financial trouble. The banks also want "carve outs" allowing the clauses in situations when there are senior management changes or if an external administrator is appointed.
The stoush over how broadly these clauses should be removed comes as the Australian Securities and Investments Commission and Ms Carnell's office team up to increase the scrutiny of bank lending contracts with small business.
ASIC's deputy chair Peter Kell said on Thursday ASIC wants to use the unfair contract provisions "to raise small business lending standards". He threatened to take banks to court to decide whether or not a term is unfair if banks don't remove clauses identified by ASIC.
Ms Carnell said she believes loan contract terms in current bank contracts fail to comply with the new unfair contracts laws. These was "a chance for the banks to show they're serious about change, but they didn't do it, so for me, that casts doubt on their overall commitment to small business lending reform going forward", she said.
During hearings over the past week, the banks set out their respective positions on non-monetary default clauses.
Westpac Banking Corp said it is committed to removing non-monetary covenants from all small business loans under $1 million which are secured against property, and wants to extend this to most loans under $3 million.
ANZ Banking Group said it doesn't enforce non-financial default clauses in loans under $1 million. But the clauses remain in the contracts. ANZ said it would consider the future use of terms in loans up to $3 million, but did not commit to removing them.
Commonwealth Bank of Australia committed to removing non-monetary default terms from agreements for loans up to $1 million said it would consider doing this for loans up to $3 million.
National Australia Bank said it is opposed to the removal of non-monetary covenants. "If there is security, it does inform the price we charge the client, and the amount of lending we do. We do have concerns that if that were to be removed," NAB chief executive Andrew Thorburn told the committee. "We think there would be unintended consequences of that ... The price would be higher, and there will be less lending done into the small business economy."
Based on the last few days of hearings in Canberra, Ms Carnell said: "If I had to say who seems to be the most responsive to change, I'd say Westpac are ahead of the other big four, with NAB bringing up the rear."
ASIC and the Australian Small Business and Family Enterprise Ombudsman said on Thursday they are concerned that unfair contract laws may be breached by clauses that give lenders a broad discretion to unilaterally vary terms and conditions of the contract, provide for loan default in a very broad range of circumstances, absolve lenders from responsibility for conduct, statements or representations they make to borrowers outside the contract and those that too broadly indemnify the lender against losses, costs, liabilities and expenses.This article was first published by www.afr.com.au
Author: James Eyers