Small businesses seeking bank funding have become royal commission collateral damage, with credit drying up as banks impose tighter assessments of mortgages following the Hayne inquiry.
The dilemma has arisen because homes are used as security for many small business loans.
This has prompted an urgent warning from the small business ombudsman, Kate Carnell, for the banking royal commission to recognise that loans secured by residential property must be assessed differently from consumer mortgages, to ensure capital continues to flow into SMEs to allow them to drive economic growth.
"There's a real chance the royal commission will come down hard on serviceability and that could dramatically escalate problems small business is having accessing credit, because banks are requiring small businesses to pass hurdles that weren't put in place for them at all, but for consumers," said Ms Carnell, the Australian Small Business and Family Enterprise Ombudsman.
"It is really important that Commissioner [Kenneth] Hayne doesn't make it more difficult for small business to borrow. If significantly greater requirements are placed on banks' capacity to lend with regard to home loans, the flow-on effect to business is significant. It is already flowing through really badly because of APRA requirements.
"But we have to see small business loans secured against property really differently."
Reserve Bank governor Philip Lowe and Treasurer Josh Frydenberg have repeatedly expressed concerns that the Hayne royal commission could prompt a credit squeeze.
RBA figures showed business credit growth was just under 5 per cent for last year but most of this growth reflects stronger merger and acquisition activity and lending to larger companies. When this is stripped out, SME lending growth has slowed to zero.
"Small business credit growth has slowed dramatically in recent months, with anecdotal evidence now suggesting the current trend is towards flat growth across our economy," said the chief executive of Westpac's business bank, David Lindberg.
"At the request of the Treasurer, the Australian Banking Association is working with banks to find ways to increase lending to small businesses and we are pleased to be actively involved in this important initiative."
Industry sources said banks are interpreting current regulatory guidance as requiring the application of consumer loan processes to business loans secured by residential property.
Pressure is growing on the corporate and prudential regulators to give the banks fresh guidance, to create confidence to assess business lending in a more accommodative way. This may require the Australian Prudential Regulation Authority and Australian Securities and Investments Commission to adjust their responsible lending guidance.
Unfit for purpose
Hindering small business credit growth via tougher mortgage assessments could be a concern for the federal government, which is keen to make small business lending an election issue. It announced a new small business growth and securitisation fund, to encourage banks to support growing small businesses. The fund was created on the urging of the ASBFEO.
Commissioner Kenneth Hayne is being asked to avoid the unintended consequence of stifling small business lending if stricter duties are imposed on mortgage assessments. Brook_Mitchell
While Ms Carnell welcomed them, she said tighter bank assessments of SME loans would have a much larger negative impact on the economy than the positives coming out of the funds.
The nub of the problem is that banks have been assessing business loans secured by residential property as though they are mortgages. The issue is challenging because SMEs frequently co-mingle their business and personal cashflows and often do not distinguish between their personal and business borrowings.
In the past, banks were able to project expected business revenue growth in place of strict serviceability calculations, but this has tightened up as regulators honed in on responsible lending duties when the Hayne inquiry suggested they weren't being applied strictly enough.
But many small businesses have lumpy revenue, and SME owners don't get a fortnightly pay cheque, which "doesn't suit serviceability requirements aimed at consumers," Ms Carnell said. "This means we could see small businesses not pass requirements created for consumers getting a fortnightly salary."
Westpac's head of business banking David Lindberg raised the issue in Canberra in December. Dominic Lorrimer
She acknowledged "what is happening to property prices in a number of capital cities just exacerbates the problem".
Analysts are expecting the final report of the banking royal commission, due on February 1, could call on banks to reduce the use of discretion and estimates when assessing mortgage loans.
"We believe the royal commission may recommend full verification of expenses, which further reduces borrowing capacity and increases mortgage mis-selling risks," said UBS banking analysts Jonathan Mott and Rachel Finn.
The industry is hoping the royal commission makes it clear to regulators that small business should be carved out from the standards applied to retail borrowers, after its SME hearings failed to find systemic problems with business lending.
Compensating past cases
Another issue for the government to consider is its response to dealing with legacy complaints by small businesses against banks.
The government parked its response during the course of the commission to the review by legal academic Ian Ramsay, which found there was a strong case for legacy cases to be paid out subject to appropriate funding.
While the commission heard case studies from several aggrieved bank customers during the course of last year, it could not adjudicate on compensation.
Professor Ramsay proposed government-led options including support for funding legal cases, the creation of a new body to examine past disputes, or a compensation scheme for exceptional circumstances. He also proposed an industry-led option of a forum or special panel to hear past disputes.
"The government will need to respond to Ramsay after the royal commission is published in February and it needs to look at what a system would look like to give these past cases an opportunity to be heard," Ms Carnell said.
"A system needs to be put in place to triage these cases, and look at the ones with real issues that need to be heard, and potentially compensated."This article was first published by https://www.afr.com
Author: James Eyers