Chapter 3
Causes of the slowdown in small business finance
Introduction
3.1
The previous chapter showed that, since the global financial crisis,
there has been a marked slowing in the provision of credit to small businesses
in Australia. Assessing whether there is a widespread or systemic 'credit
crunch' applying to small business finance is quite complicated, as there are a
myriad of simultaneous influences (In economic jargon, there is an
identification problem, with movements both of and along the demand and supply
curves.)
3.2
The slowdown in lending to small business appears to reflect a
combination of demand factors such as;
- less demand for finance by small business in the wake of the
global recession, as weaker sales mean that existing capacity is adequate and
there is not the need to borrow for investment;
- less demand for finance by small business as reduced confidence
leads to a more conservative attitude towards debt;
and supply factors such as;
- fewer small businesses being able to meet existing lending
standards in the wake of the global recession;
- some tightening of lending standards by financial intermediaries.
It is arguable that banks were tending towards recklessness in the preceding
boom, and that some tightening of credit standards represents a prudent return
to 'normal' practice, but there may also be cases where banks are over-reacting;
and
- non-bank lenders having fewer funds available as securitisation
and interbank lending markets dried up and/or interest rates in them became
prohibitive.
3.3
Witnesses and submitters were hesitant to apportion the credit slowdown
between demand and supply influences. For example, the Reserve Bank concluded:
Lending to small businesses has been little changed over
2009, after growing steadily over prior years. The slowdown reflects both
reduced demand from small businesses and a general tightening in banks’ lending
standards. Small businesses in most industries have been able to access funding
throughout the financial crisis, albeit on less favourable terms than
previously.[1]
We think the slowdown in lending reflected both supply and
demand factors. On the demand side...there was reduced demand reflecting the
state of the economic cycle. On the supply side there was a general tightening
in banks’ lending standards. Nevertheless, as we have said in our submission,
our assessment is that small businesses in most industries have been able to
access funding through the financial crisis, albeit on less favourable terms
than they were previously.[2]
3.4
The prudential regulator's perspective is that banks are not singling
out small business for reductions in credit:
...we do not see that the banks are treating small business
differently from how they are treating other clients.[3]
3.5
They were also agnostic about the relative importance of demand and
supply factors:
...there were two elements—a demand impact and a supply impact.
I do not really know which one dominated.[4]
3.6
Treasury also referred to both demand and supply factors without
indicating which predominated:
On the demand side, businesses have been deleveraging to
strengthen their balance sheets and have cut back their investment plans in
line with global economic weakness. On the supply side, banks have faced higher
funding costs due to the global repricing of risk and have also raised their
assessment of small business risk, reflecting the point in the economic cycle.[5]
Demand for credit by small business
3.7
On the demand side, the Reserve Bank note that small business has scaled
back investment plans (Chart 3.1).
Chart 3.1: Small
business investment expectations
Net balance:
deviation from long-run average
Source: Reserve Bank of
Australia, Submission 2, p. 3.
3.8
Similarly, APRA noted:
...the smaller end had a fall-off in their approach to the
banks and other lenders for loans.[6]
3.9
The banks referred to a reduction in demand for credit:
...we saw demand, particularly in the September quarter of
2008, start to contract quite markedly. It is pretty fair to say that since
that time credit demand in this area has been flat...[7]
Since the beginning of the global economic crisis, overall
lending to business has been subdued both at ANZ and other lenders. This
primarily reflects a fall in loan application numbers due to reduced demand for
credit in uncertain times and to a lesser extent a tightening in credit
criteria.[8]
Supply of credit to small business
3.10
On the supply side, APRA observe:
On the supply side, after something like the global financial
crisis, the increase in arrears rates and non-performing loans, the authorised
deposit-taking institutions and other lenders actually tightened up their
lending terms, as would be expected after something like the global financial
crisis. The ADIs did things like reducing the maximum loan they would give to
particular classes of borrower, they lowered maximum loan to valuation ratios,
had higher interest coverage ratios—those sorts of things—to tighten up their
terms, with more stringent covenants, and hence there was a drop-off in
the available supply.[9]
3.11
Similarly,the Reserve Bank note:
Small business borrowers have faced lower loan-to-valuation
ratios, stricter collateral requirements and higher interest coverage ratios.[10]
3.12
This conclusion is supported by CPA Australia. A survey of their members
concluded:
The banks are still lending but mostly where the loan is
fully secured by a tangible asset and personal guarantees (and in some cases,
also key man insurance). Where there is an existing loan, banks are requiring
additional security. In summary, members stated that lenders were no longer
prepared to provide finance on ‘soft’ security such as cash flow or goodwill
(unsecured finance) - which had been available pre-GFC.[11]
3.13
This reflects the increase in non-performing business loans in recent
years. As the bankers put it:
Banks were right to look at business, in particular small
business which is inherently more risky, as a source of potential increases in
bad debts. The number of business loans that are 90-days plus in arrears or
over three months outstanding has increased significantly over that time, which
underlines the fact that the banks were right to see this as being a riskier
area of lending.[12]
3.14
The bankers contrasted the risks in business lending compared with home
lending:
That figure is seven times higher than what home lending is,
so to compare it with home lending, which is a relatively safe and secure form
of lending, business lending is less safe and banks have been right during the
economic times to make sure that they are lending appropriately.[13]
3.15
While Chart 3.2 suggests the increase in non-performing business loans
may have been smaller for small business than for larger firms, it has been
significant for both.
Chart 3.2: Banks'
non-performing business assets
Share of outstanding
lending
Source: Reserve Bank of
Australia, Submission 2, p. 5.
3.16
Chart 3.2 refers to the aggregate of all banks. The Commonwealth Bank
told the Committee that:
Pre, post and during the GFC we have not seen any significant
change in the credit quality of our book, nor the rate of arrears and the
number of people that we pass on a monthly basis to what we call our credit
services— businesses that are struggling go across to that unit first off—has
not changed at all over the last two years.[14]
3.17
The National Australia Bank reported fewer bad debts among small than
larger businesses:
Senator XENOPHON—In your submission you said that the $13
billion in bad and doubtful debt that the bank reported in 2009 was largely
from its business lending activities. How much of that was related to small
businesses...?
Mr Healy—The bulk of that would be mid sized and larger
businesses, rather than small businesses...Small businesses were helped last year
by the government stimulus, which helped many segments of the small-business
market. Whilst I do not have the exact figures, the majority of that would have
been geared more towards mid sized and larger companies.[15]
3.18
One view is that the tightening in the supply of credit is an
appropriate return to more prudent behaviour after excesses of the recent boom:
Prior to the GFC the spreads on lending were probably the
lowest they had been for the statistics that had been collected. There had been
15 years of economic good times, and non-performing loans were at historical
lows. I think there was a movement towards lending perhaps without the risk
based pricing that should have really been there just prior to the GFC hitting,
and then there was some correction after that.[16]
...one of the factors about the global financial crisis is that
people reacquainted themselves with the discipline around ensuring that lending
was properly priced for risk.[17]
3.19
Other submitters assert that the banks have over-reacted and excessively
restricted access to small business finance.[18]
There is concern that some good small businesses are being denied funding:
Senator BUSHBY—...are there small businesses out there that are
quite capable of meeting loan repayments and who maybe even have a demonstrated
history of being able to meet loan repayments but who are now finding
themselves unable to secure finance either to continue or to expand on the
basis of decisions that banks have made to raise the bar in terms of lending criteria?
Dr Burn—We fear that that is the case. We do not have any
direct evidence about that.[19]
3.20
On the other hand, Westpac's interpretation is as follows:
...our approximate one per cent decline in business lending in
that year was in line with system lending. Analysis of this data highlights
that much of this decline was demand-driven and symptomatic of cyclical
economic conditions. In Westpac’s view, the decline in lending is a result of a
combination of factors; business customers prudently paying down debt, thereby
reducing their gearing, and an increase in applications falling short of
underwriting standards. The latter is supported by an increase in credit bureau
default rates for customers applying for credit. This implies a higher
proportion of SME customers applying for credit have a greater risk of
defaulting on their debt... Westpac’s rate of overriding adverse credit bureau
decisions has remained steady in order to support more SME borrowers and
overall approval rates have remained high at above 85%...during the past 18
months, Westpac has made no major changes to key SME credit policies relating
to debt service cover, interest cover, Loan-to-Value-Ratios (excluding
commercial property) or other credit policies...[20]
3.21
The Australian Bankers' Association emphasised that:
...banks need small business to be doing well for banks
themselves to be doing well.[21]
3.22
They did concede, however, there had been some tightening of supply of
credit, referring to:
...changes that banks have reasonably and prudently made in
their approach to lending through the course of the global financial
crisis...banks have taken a more stringent approach to lending. There is no doubt
about that. [22]
3.23
The Australian Bankers' Association argued though that reported
instances of undue tightening of credit were rare not typical:
There will always be businesses, for some reason or another,
that are finding it difficult to get credit, or to get credit on the terms that
they previously had or the terms that they want. Where opportunities are
provided for small business to come forward with specific examples these
examples exist, but they tend to be a small number. The government’s own
clearing house, Hotline for Small Business, has attracted less than 100 calls
in the time that it has been set up since March last year, just over 12
months...we need to be careful to extrapolate that to suggest that there are some
system-wide issues.[23]
3.24
The reduction in supply of credit is more dramatic from non-ADI lenders.
As the bankers put it:
...there were businesses prior to the financial crisis that
were only able to raise money because money was dirt cheap and because there
were a lot of people out there who were providing money on very limited risk
analysis. When those elements have been removed then obviously there is going
to be a tightening.[24]
3.25
The banks referred to having:
...picked up a lot of customers from lenders who are no longer
operating because of changes in credit markets.[25]
The impact of Basel capital
requirements
3.26
Bank supervisors from around the world, meeting at the Bank for
International Settlements in Basel, have agreed on rules governing capital
requirements for banks which APRA implement in Australia. Some witnesses
believe that these rules could discourage lending to small businesses as more
capital is required to be held against small business loans than for home
loans:
Several commentators have pointed to Basel II regulatory
capital requirements as a factor leading to higher costs for small business and
a skewing away from business lending as under Basel II banks have to provide a
higher level of capital reserves for business loans.[26]
Prima facie, Basel II makes it more attractive for a bank to
lend to the household sector than to small business. In fact, we have the
perverse situation where it is more attractive to lend for a weekend holiday
home than to a small business...there is more capital involved in supporting
small business lending as distinct from household lending, and that creates a
bias.[27]
3.27
APRA responded:
It is feasible in certain circumstances that some loans could
have quite significantly higher capital requirements and it would look, to
somebody looking at the underlying security of that loan, as if they were the
same. I will take small business as an example, and one that is secured against
a residential mortgage as opposed to an owner occupier buying their house. The
risk profile is quite different, as I am sure some of the submissions have
indicated. The underlying default rates and arrears rates on owner occupied
homes and investor lending is a lot lower than it is for small and medium sized
enterprise loans that are secured against the residential mortgage. They have a
far higher likelihood of what they call 'probability of default rates' and 'loss
given default' than do the normal residential mortgages. Basel II, as a whole,
is intended to be risk based, so it actually ensures that the capital that is
being held is commensurate with the risk of the loan, and that is whether it is
a low-doc mortgage loan, an owner occupier through to a large corporate loan
that is unsecured; it differentiates the security and basically has capital
according to the underlying risk profile. By itself it is attempting to be a
better way of ensuring proper capital is held for the risk faced. That may mean
that you do have differences according to sector because of the nature of the
business, the risks in the business, the nature of the security and that sort
of thing...There are two forms of the capital regime. One is what we call
standardised, which is for basically the non-model users, the smaller
authorised deposit-taking institutions and banks have not got approval to
use an APRA model. We basically specify what risk weights you use. For example,
if you have an SME or a corporate loan that is unsecured it would be 100 per
cent risk weight—$8 capital per $100 of loan. The larger banks have their own
models, which we have accredited over a lengthy process for them to get their
Basel II accreditation. Those models use historical data to determine the
probability of default and loss given default, on all the various portfolios
and generates a capital outcome commensurate with the risk. We have to approve
that. We monitor it closely. We compare those banks with their peers. Yes, it
will give potentially differential rates for the model users as opposed to the
standardised users, but that reflects the fact that the more complicated models
are supposed to be better at predicting the underlying risk.[28]
3.28
Since the global financial crisis there have been proposals for further
increases in capital requirements. Quantitiative impact studies are currently
underway to develop these proposals.[29]
Non-bank lenders
3.29
Small business was hurt by the impact on non-bank lenders of the global
financial crisis:
Incidentally, many small businesses had relied upon non-bank
financial institutions, regional banks and foreign banks for access to credit.
With the onslaught of the crisis, that segment of the banking system shrank
significantly and reduced capacity. They made it clear to some small businesses
that, when there facilities were due for renewal, they would be instructing
them to seek other forms of borrowing.[30]
3.30
The reduced role of non-bank lenders is discussed further in Chapter 5.
Business liasion by official agencies
3.31
The Reserve Bank's own interreactions with small business led them to
conclude:
...liaison by the Reserve Bank, including through its Small
Business Panel, suggest that small
businesses in most industries have had tighter but still reasonable access to
funds throughout the financial crisis, with property companies being a notable
exception.[31]
3.32
Treasury also talk to small business as part of their business liaison
programme. They summarised recent discussions as:
Smaller to medium-sized firms appeared generally able to
access bank credit, but could be deferring expenditure and continuing their
deleveraging until economic and financial conditions become more favorable.[32]
Business surveys
3.33
Another indication comes from surveys of businesses. The long-running
Westpac-ACCI Survey – admittedly a survey of businesses in general rather
than specifically small business – indicates that while financial conditions
are at 'tighter than average levels', they are much improved from early 2009
(Chart 3.3) and only 5 per cent of firms nominated finance as the factor
most limiting expansion.[33]
Chart 3.3: ACCI
survey – availability of finance
Source: ACCI, Submission 32, p. 17.
3.34
A specific ACCI survey found that a quarter of businesses reported that
changes in bank lending criteria had led them to revise down capital
expenditure plans.[34]
Another ACCI survey asks companies what are the main constraints on their
investment. Taxes, regulations, labour costs and insufficient demand are all
judged more important than credit-related factors.[35]
3.35
Sensis' March 2010 survey of small business found that:
...20 per cent of businesses reported it was currently
relatively easy to access finance; compared to 35 per cent reporting they felt
it was relatively difficult, and the remainder feeling that current lending
conditions were fairly normal.[36]
3.36
The Deloitte survey of chief financial officers in late 2009 found that
80 per cent them regarded credit as costly but they were evenly divided on its
availability.[37]
A survey by the Chamber of Commerce and Industry of Western Australia found
that a quarter of small business respondents rated borrowing costs among the
top three issues affecting them.[38]
A Telstra-sponsored survey of small business found that 6 per cent regarded the
availability of finance as their major concern while 38 per cent regarded its
cost as their major concern.[39]
A survey of real estate agencies found that three-quarters felt that
access to finance was more difficult than before the global financial crisis
and four-fifths believe lending conditions are stricter.[40]
Another survey found that 'over 77 percent of retailers are concerned or very
concerned about current difficulty in accessing finance'.[41]
A survey of residential builders found that 75 per cent faced greater
difficulty obtaining finance than was the case before the global financial
crisis.[42]
3.37
The Australian Industry Group told the Committee that around a quarter
of respondents (both large and small firms) to a recent survey it conducted
identified the availability of credit as a negative influence.[43]
For small businesses, this was slightly lower than the proportion in 2009.
3.38
A survey of such surveys by the Reserve Bank suggested to them that:
Small business surveys provide mixed evidence on the
availability of finance. Some business surveys, such as the PwC/East & Partners Business Barometer and the ACCI Small Business Survey, suggest that
over the past year the availability and cost of intermediated debt has been a
constraint on small businesses. However, others, such as the Sensis Business
Index and the NAB SME Survey suggest that the cost and availability of debt
financing is a concern for relatively few small businesses, with issues such as
lack of sales, future cash flow and the economic climate being more important.[44]
Comments by business organisations
3.39
The cost and availability of finance was described by the general
council of ACCI as:
...the most significant day-to-day issue facing Australia’s
businesses.[45]
3.40
Similarly, the Council of Small Business of Australia described the cost
of credit as:
...the No. 1 issue for small businesses in Australia.[46]
3.41
Turning to individual sectors, the Housing Industry Association opined
that:
The lack of access to finance for residential development is
restraining the supply of new housing across Australia... banks are rationing
credit to small residential developers, placing an enormous pressure on their
cash flow, while at the same time banks are extending a ‘normal’ stream of
credit to households in the form of mortgages.[47]
3.42
Three-quarters of their members reported greater difficulty in
attracting finance than before the global financial crisis.[48]
3.43
Similarly, when the Real Estate Institute of Australia surveyed their members:
...three-quarters of respondents felt that access to finance
was more difficult than it was before the global financial crisis. This was
despite the fact that two-thirds of respondents felt that their financial
position was either the same or better than it was 12 months earlier.[49]
Obtaining better information
3.44
The Australian Securities and Investments Commission has a suggestion
that may improve information on this topic:
Currently, Australia does not have a dedicated senior loan
officer survey to determine the supply and demand conditions prevailing in the
small and medium-sized enterprise (SME) lending market. Such lending surveys
currently exist in a number of countries including the United States of America
(US), the United Kingdom, Europe and Japan, and have been useful in researching
the lending demand and supply dynamics for both SMEs and large firms. For
example, the US Federal Reserve issues the ‘Senior Loan Officer Opinion Survey
on Bank Lending Practices’.[50]
Demographic factors
3.45
The retirement of the baby boomer generation may generate an increase in
demand for small business finance. Dr Seet and Dr Graves from the University of
Adelaide submitted that:
...it is anticipated that around 60% of family business owners
plan to retire by 2016. Although the majority of family firms intend to pass
the business onto the next generation, it is predicted that half will be unable
to do so due to a lack of available and / or suitable successors. As a
consequence, many family owners will have little option but to sell or close
down the business. The scale of this problem suggests that not all family
business owners can look forward to traditional exit options such as trade
sales, and therefore alternative succession strategies, such as the involvement
of PE [private equity], need to be considered. The successful ownership
transition of family firms (e.g. to next generation, management buy-out or
sale) is critical to the Australian economy as it is estimated that a
successful transfer conserves, on average, five jobs, whereas a start-up
generates on average two jobs.[51]
3.46
The authors warn, however, that private equity is reluctant to invest in
small business and small business is distrustful or ignorant of private equity
investors. This makes the role of lenders in facilitating the transfers of
small business all the more important.
The outlook
3.47
Treasury were confident that lending to small business would pick up in
due course:
Going forward, it is anticipated that conditions will improve
as the economy recovers and global funding markets re-establish themselves.
Investment is expected to recover, risk margins are likely to fall and some
lenders that have been forced to scale back their activities as a result of the
crisis will be in a position to re-enter the market.[52]
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