Interest rates will be forced up and lending to small business restricted if the federal government extends unfair contract laws to credit agreements that banks make with customers.
This warning was made by the Australian Bankers' Association as submissions to a Treasury consultation paper were due on Friday. It questioned whether laws allowing individuals to use the Australian Consumer Law to protect themselves from unfair terms in standard form contracts should be extended to small business.
Some submissions to the review by Minister for Small Business Bruce Billson fingered clauses in bank credit contracts - such as those that allow banks to trigger defaults if loan-to-property-value ratios are breached or if the earnings of the business fall below a certain level - creating a significant imbalance of negotiation power between banks and small businesses.
In his submission to the financial system inquiry, Mr Billson said he had been told by small business owners that "covenants on loans can be very restrictive, therefore limiting the ability of a small business to grow".
He also reported concerns from small business "about the propensity for banks to quickly force small businesses that default on their loans into insolvency, rather than working with the small business to get them back on track".
But ABA chief executive Steven Munchenberg responded with a stern warning to Mr Billson that if banks were prevented from using such clauses, this would reduce banks’ ability to control risk, and lead them to increasing the price of loans to small business.
“Contracts look to favour the banks but [are] necessary to maintain control of risk in small business lending books,” he said.
“I am concerned that both publicly and privately Mr Billson has indicated his starting position is [that] those are potentially unfair contract terms.
“Our concern is those provisions that, on their face, can look to be fairly well weighted to the banks' favour are nonetheless [an] important mechanism for us to manage our exposure to the people we lend to.
“For example, what they allow banks to do is, if we become aware a business is selling off assets, that we're there to secure the loan - we can act.
“If those provisions are taken away from those contracts, it raises the risk of lending to all small business because our ability to manage loans as they start to get into difficulty is restricted and therefore it becomes riskier there is a larger likelihood we will lose money.
“Unfortunately, we can’t tell which loans are going to go bad.
“Therefore we have to assume all small business loans could become risky and the government needs to be very careful that in, attempting to address concerns in this area, they don’t actually increase the risk of lending to small business which is already a higher-risk lower-yield area of lending.
“And that is going to influence the price of credit.”
Mr Munchenberg said if the minister had concerns around specific clauses, the industry would be willing to discuss these but “that does not mean all bank credit contracts have to be subject to unfair contract laws”.
Mr Munchenberg said extending the unfair contract laws to credit contracts would create a large cost burden on the industry.
He pointed to unfair contracts with customer contracts a few years ago - lawyers needed to review 1000 per bank but nothing significant was found and big costs were taken up front, resulting in “a significant expense”.
He also had discussions with small business not concerned about credit contracts but leases.
“We have long been putting the argument to Mr Billson that while we recognise they want to bring in unfair contract legislation, the issues they are trying to solve are not in the bank/credit space, and therefore there is no need for these laws to be included (extended to banks).”
But according to a submission sent to Treasury, unfair contract laws should be extended to any financial service or credit contract entered into by a small business with a credit provider as defined by the National Consumer Credit Protection Act.
"There is currently very little room for a business to negotiate for financial services for banks. This goes to the imbalance of power between banks and small businesses which is why banks can rely on draconian clauses embedded in credit contracts to call in loans."Author: James Eyers
Source: Sydney Morning Herald