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Will Hayne tackle the real small business gripe with banks?

According to Small Business Ombudsman Kate Carnell, a "huge percentage" of banking misconduct cases involve small businesses. Sean Davey According to Small Business Ombudsman Kate Carnell, a "huge percentage" of banking misconduct cases involve small businesses. Sean Davey

Banking royal commissioner Kenneth Hayne can look forward to spending a lot of his time in coming months listening to small business owners and farmers outline the shabby treatment they've received at the hands of their bankers.

According to Small Business Ombudsman Kate Carnell, a "huge percentage" of banking misconduct cases involve small businesses.

"Banks have acted in a way that has produced significant hardship, if not bankruptcy, for many small businesses," she told The Australian Financial Review.

Often these business owners had pledged their family homes and other assets as security for their loans, and the banks' behaviour "means that they lost everything".

In his first speech since taking charge of financial markets in December, RBA Assistant Governor Christopher Kent noted bond markets played a key role in mining companies' moves to rein in spending. Brendon Thorne

While the banking royal commission will provide an opportunity for small business owners to vent grievances against their bankers, it remains to be seen whether it will look into the broader complaint that they have against their bankers: their reluctance to lend.

"The major banks have 80 per cent plus of the small business market, and they're unwilling to lend at all: or only when there's bricks and mortar; and they're imposing increasingly tougher LVRs [loan-to-valuation ratios]," Carnell said. "The dilemma of access to finance is real and increasing."

Of course, small businesses have long complained about being mistreated by their bankers. Despite their huge economic importance – they employ close to five million people, and account for about one-third of all business output – smaller firms continue to struggle to get bank loans, and, when they do, they face considerably higher borrowing costs than, say, home owners or big businesses.

The debate, however, is a fractious one. Senior bankers take umbrage at the accusation that they are starving small businesses of credit.

Instead, they point out that small business lending is inherently risky and that banks are exposed to hefty write-offs from souring businesses.

What's more, they argue that it's clear the banks aren't over-charging business customers because the country's two most business-oriented banks - National Australia Bank and ANZ Banking Group - have lower returns on equity than either the Commonwealth Bank or Westpac.

There's also the problem of scale. Bankers argue that it is impossible for them to allocate a lot of human capital to assessing the creditworthiness of the borrower, because the relatively small size of the loans means that margins aren't sufficient to cover the cost of the labour.

"All the banks recognise there is a big opportunity in small business lending", one senior banker told the Financial Review.

"But the loan sizes are relatively small, the risks are high, and small businesses are extremely leveraged to the overall economy."

But while bankers may defend their actions, the issue of bank lending to small businesses is of increasing concern to the Reserve Bank of Australia.

Martin Place is worried that the banks' reluctance to lend to small businesses is hampering Australia's broader economic recovery.

In a wide-ranging speech last month, Christopher Kent, the Reserve Bank's assistant governor (financial markets) pointed out the big banks (and some foreign banks) are competing heavily to lend to big companies - which has pushed their borrowing costs close to historic lows.

In contrast, small businesses continue to find it difficult to get bank loans. "Indeed, this could be one factor that helps to explain why investment by small businesses has been unusually weak over recent years," he said.

Banks, along with other investors, tend to shy away from smaller, newer businesses, because they tend to be riskier than larger, more established firms, and there is less information available.

"Lenders typically manage these risks by charging higher interest rates than for large business loans, by rejecting a greater proportion of small business credit applications or by providing credit on a relatively restricted basis", he said.

One way that small businesses can get loans at more reasonable interest rates is by putting up their house as security for their loan.

As Kent noted, "lenders have indicated that at least three-quarters of their small business lending is collateralised and they only have a limited appetite for unsecured lending."

But not every small business owner can pledge their home as security for a bank loan. Some may not own a home, or they may have too little equity to satisfy a bank; others may have already borrowed against their home already in order to set up the business.

And some may not like the idea that they'll lose the family home if their business fails.

So what hope do small businesses have of ever persuading bankers to open their purse-strings?

Kent outlined a number of key changes that improve small businesses' access to financing.

The first is comprehensive credit reporting. Last November, Treasurer Scott Morrison announced the federal government will introduce laws to mandate "positive credit reporting" by the middle of next year.

Canberra will require the major banks to have 50 per cent of their credit data ready for reporting by July 1, increasing to 100 per cent a year later.

At present, banks only report "negative" credit history, such as overdue debts, defaults, bankruptcies or court judgements. In contrast, "positive" information will include customer's repayment track record and their credit history.

As Kent noted, "when information about credit that has been repaid without problems also becomes available publicly, the cost of assessing credit risks will be reduced and lenders will be able to price risk more accurately."

In addition, the measure could also "enhance competition as the current lender to any particular business will no longer have an informational advantage over other lenders."

Another change could come with the introduction of an open banking regime, which would allow small business owners to share their banking data - including cash flows - with other potential lenders.

There could also be competition from large tech companies, such as Amazon and Pal, which have the ability to use transactional data from their platforms to identify high-quality borrowers.

Bankers, however, are sceptical that these changes will cause competition in small business lending to heat up significantly.

Instead, they say, what's likely to happen is that all banks will focus on cherry-picking the better quality small businesses, trying to attract their business by offering them slightly better rates than what they're currently paying.

"There's an opportunity to grow small business lending, but the challenge is working out who to lend to," one banker said. "If you can weed out the bad risks, you can make a lot more money."

This article was first published by
Author: Karen Maley
Last modified onWednesday, 17 January 2018 02:23

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