The Reserve Bank of Australia’s latest report, Access to Small Business Finance, reaffirms the findings of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) that small businesses — around one in five in Australia — are still struggling to access finance to support trading activities and growth, despite conditions improving since the global financial crisis.
The central bank’s report notes that small businesses do not always pay their taxes on time, using the deferred payment as “a relatively cheap form of finance”.
In June 2017, the Australian Taxation Office (ATO) was owed $14 billion in collectible tax debt by small businesses, which the RBA said makes the ATO “one of the single largest lenders to small businesses”.
However, as the Reserve Bank highlighted, delaying paying taxes exacerbates the problem of SMEs struggling to access finance as “unpaid tax debts negatively affect assessments of [a small businesses’ creditworthiness”. The RBA said that many SMEs are seemingly unaware of this effect.
“To manage this, the ATO offers payment plans for small businesses at concessional interest rates that are often cheaper than bank finance. In 2016–17, the ATO negotiated 650,000 tax debt payment plans for small businesses; this implies that a significant proportion of small businesses could be on tax debt payment plans,” the RBA report states.
“These payment plans help small businesses to manage their cash flows, but businesses also need to be aware of the longer-run implications of maintaining tax debts.”
Feedback from the Small Business Finance Advisory Panel suggests that there are a number of issues around SME lending, such as higher interest rates, cumbersome application process, restrictive contract terms and the predominant use of residential property as security, the RBA said.
The central bank’s report indicates that small businesses pay rates that are around 2 per cent higher than that of big businesses, which is in line with the findings of the Productivity Commission (PC).
It reported that interest rates for small business loans and overdrafts secured by residential property are 1 per cent to 4 per cent higher than what large businesses are required to pay for similar products.
Further, the RBA noted that small businesses find it difficult to borrow more than $100,000 on an unsecured basis, while medium-sized businesses find it hard to obtain additional finance once they’ve used all their property as security, resulting in delayed expansion plans.
Meanwhile, the loan application process was reported as lengthy and onerous as businesses have to provide a large amount of information and documentation, then wait for extended periods of time for the bank’s decision, which can be particularly inconvenient when a business opportunity is time-sensitive.
The banks’ reluctance to provide guidance on the process to SMEs was also highlighted in the RBA report as compounding the problem.
“While innovative non-bank lenders are offering products with streamlined application processes, the annualised interest rates on these products are often very high,” the RBA added.
Banks told the RBA that their SME loan portfolio had in fact grown, but at a slower rate than big business loans, further stressing that difficulties in accessing unsecured finance are reflective of the higher risk associated with this form of lending.
The PC had also stated that banks consider lending to SMEs riskier, costlier and less profitable than residential lending, especially if the business has limited financial history and no property to use as collateral.
Based on data provided to the PC, the average return on equity over the last five years for residential lending was 7 per cent higher than for SME lending for one major bank and 4 per cent higher for another.
The Reserve Bank’s report additionally acknowledged the PC’s concerns around the effect of prudential requirements on SME lending.
The PC had previously flagged that the Australian Prudential Regulation Authority applies a single risk weight (of 100 per cent, but could be reduced to 85 per cent in 2021) to all unsecured SME lending.
That means local lenders are generally required to hold more regulatory capital than lenders using internal ratings-based models and more than that required under the internationally agreed Basel requirements.
“This approach to risk weights skews competitive opportunity away from consumer interests and provides strong incentives for both lenders and SME borrowers to secure a business loan with a residence as collateral,” the PC noted.
The central bank presented a collection of recommendations that was drawn from feedback from market participants, including the ASBFEO’s recommendation to establish a Business Growth Fund that provides long-term finance solutions to SMEs.
Specifically, the ASBFEO suggested that through such a fund, SMEs would be able to apply for loans between $250,000 and $5 million, with terms up to seven years, secured against the business.
The ASBFEO’s proposals to launch a government guarantee scheme as well as to establish a fund to reduce the cost of capital by purchasing hybrid capital instruments issued by smaller lenders were also mentioned in the RBA report as possible solutions to improve SME access to finance.
Additionally, extending the mandatory comprehensive credit reporting regime to include small business and commercial lending data could be helpful in providing lenders with better access to information that would allow them to more accurately assess lending risks, the Reserve Bank said.
“The regime only covers providers of consumer credit and there is a reciprocity requirement for lenders to be able to access the data. As a result, new online providers of small business finance cannot get access to the information since they do not provide consumer credit,” the RBA report states.
“This could be resolved if consumer credit providers agreed to relax the reciprocity requirements for specialist small business lenders.”