One of the most striking trends in modern finance has been the shift in the profile of bank lending. Thirty years ago banks lent twice as much to businesses as they did for housing. Now it’s the other way around, with banks now lending almost twice as much for housing as they do for business.
This shift has been driven by a number of factors, including: the advent of mortgage-backed securities, which have turned housing into a liquid asset for banks; and tax incentives for investors that have increased the demand for housing.
However, a much overlooked factor is the incentive given to banks to lend for housing by prudential standards, specifically the requirements for the risk-weighting of assets. These standards are set internationally by the Basel Committee on Banking Supervision, and adopted locally by the Australian Prudential Regulation Authority (APRA). Since the Basel I Accord in 1988 there has been a lowering of the amount of regulatory capital that a bank must hold against mortgages, even more so for those banks authorised to adopt an internal risk-based (IRB) approach to establishing mortgage risk-weights.
The result of all this is that the cheapest money in history is going towards speculation in real estate more than it is going towards productive investment by businesses.
For small and medium sized enterprises (SMEs), the effect is doubly crippling. As well as skewing bank lending towards housing rather businesses, prudential standards skew bank lending towards business owners that own housing rather than business owners that don’t. In other words: it’s not the merit of the business that matters; it’s whether they own land.
The Productivity Commission explains the effect this is having:
Continued reliance on having a home as security for a business loan—in an era when home ownership in the key entrepreneurial period of life is at a low—will increasingly inhibit SME growth. Around one third of major bank SME loans, and often a higher proportion of smaller lender SME loans, are secured by a home.
The Productivity Commission is clear on what the policy response should be:
… the reform that would most significantly improve SME access to finance [would] be changes to the underlying prudential requirements for SME business lending compared with lending for residential mortgages.
The Productivity Commission also explains how the existing rules favour those banks with IRB accreditation:
For SME loans, APRA currently applies a single risk weight (of 100%) to all SME lending not secured by a residence, with no delineation allowed for the size of borrowing, the form of borrowing (term loan, line of credit or overdraft) or the risk profile of the SME borrowing the funds … This means that most lenders are generally required to hold more regulatory capital than are lenders using IRB models and more than that required under the internationally agreed Basel requirements.
As a consequence, for a SME loan that is not secured by a residence, Australia’s smaller banks need to hold up to twice as much capital as the major banks—in effect, paying up to twice as much to be able to offer loans to their customers [emphasis added].
This brings us to this bill. The ABGF will provide a concession on the risk-weighting of loans to SMEs for participating banks. The major banks and Macquarie are five of the six participating banks. The major banks and Macquarie also happen to be five of the six banks that are privileged in having IRB accreditation.
In other words, those banks that are already being given a competitive advantage through preferential prudential rules will be given a further competitive advantage through even more preferential prudential rules. Instead of providing the structural reform needed to direct capital towards more productive investment—including in the transformation to a low carbon economy—the ABGF will further entrench the market power of the major banks.
The government’s rush to establish the ABGF is both very concerning and very telling. The two weeks given to this committee to conduct an inquiry into this bill was ridiculously short. This haste might be explained by the failure of the government to have gathered even the most basic of information about the market that ABGF is seeking to intervene in, let alone establish what the problem is and why the ABGF is a solution.
The government has been unable to provide to the committee adequate information on: the number and size of SMEs seeking access to equity finance; who is currently providing equity finance for SMEs; or why SMEs are or aren’t getting access to equity finance. It follows that the government has not been able to identify the actual market failure the ABGF would address—the underlying bias in prudential regulations has not explicitly been identified by the government as a problem, which also explains why is has only been incompletely addressed, and only addressed at the expense of competition.
Further, Treasury did not invite non-bank and non-superannuation financers to participate in the roundtable to discuss the design of the ABGF. As a result, the government has not considered the proposal to instead use the ABGF to provide underwriting for equity financing from all sources, rather than simply giving the banks a leg-up over direct investors.
Much has been made by the government and the Small Business and Family Enterprise Ombudsman of the Reserve Bank of Australia (RBA) study into access to finance for SMEs. But, tellingly, while examining the concept of a business growth fund, the RBA did not specifically recommend the establishment of an ABGF as constructed by this bill.
Conclusion
There is clearly a need for the government to act to help SMEs get better access to finance. But the ABGF is not the answer. The ABGF is a con. It neither harnesses the power of the market, nor makes a constructive government intervention. The ABGF is simply crony capitalism.
The ABGF will lower the cost of capital for SMEs, undoubtedly. But it will do so by providing a government subsidy for the major banks to cherry-pick the best SMEs. This is not in the long-term interest of SMEs, the investment environment, or the wider economy.
The Greens support government intervention in the banking system and even the direct financing of SMEs by government for particular purposes. The government took a step forward with the establishment of the Australian Small Business Securitisation Fund. But it would be taking a step backward with the establishment of the ABGF as currently constructed.
Recommendation
That the Council of Financial Regulators be directed to conduct an inquiry into the impact that prudential regulations are having on the supply of finance to small and medium sized enterprises.
Senator Peter Whish-Wilson
Member