How to fix our dysfunctional business banking system

Government funds should be invested alongside private sector funds to fix a clear market failure to finance the growth of established Australian businesses.


1. Bank lending to SMEs is in long term decline globally and in Australia – our banks have turned into building societies and this is holding back our economy

Our banks only want to lend against houses. Since 2013, only 11% of new business lending in Australia has gone to small businesses with little growth:

  • Most of the $900bn of loans outstanding to businesses goes to the big end of town
  • $269bn lent to SMEs is swamped by over $1,500bn in residential mortgage lending
  • Banks see SMEs as a critical source of cheap deposits – SME deposits far outweigh SME loans
  • But SMEs employ the bulk of our workforce

Due to global regulatory capital rules (Basel III), mortgages are more than 3 times more profitable than SME loans:

  • Real estate carries a risk weighting of 25% but SME loans require 100% (75% if backed by real estate)
  • Banks have effectively withdrawn from their original purpose: facilitate commerce

Meanwhile SME growth and employment is constrained by lack of cashflow facilities:

  • Banks will only lend to SMEs with real estate security which is a problem in a service based economy
  • The ATO/taxpayer is forced to act as lender of last resort (ATO is owed $12.5bn in tax by SMEs and growing rapidly)
  • Tight cashflow holds back growth:
“In the presence of financing frictions, even small improvements in cash collection can have large direct effects on hiring due to the multiplier effect of working capital.”
— Harvard Business School Study “Can Paying Firms Quicker Affect Aggregate Employment?” (July 2016)

2. Credit Guarantee Schemes address this market failure

In the US, the Small Business Administration has guaranteed over $112bn of loans with a bad debt rate of less than 1%. In 2015 alone, $24bn was advanced.

In the UK, P2P lending to business has developed rapidly with support from the British Business Bank, set up in 2013-14 by the UK Government. It has a mandate to facilitate up to GBP 10bn of SME finance by 2019 acting as a wholesale bank.

  • In just the first 12 months, strong momentum was established by co-investing on fintech platforms:

“The British Business Bank is already achieving significant results as over 30,000 businesses are benefitting from its programmes. Last year, £782m of new lending and investment in UK small firms was generated by Business Bank programmes – this is double the level of activity generated by Government finance programmes to small business in 2012/13.

The British Business Bank has also played an important role in promoting a wider range of finance options. 61% of its activity is channelled through smaller investors and lenders, with only 39% of support going through the big four banks. Over the coming years, I expect that this bias away from the big banks will continue.”
— Statement by The Secretary of State for Business, Innovation and Skills (UK), Vince Cable, June 2014
  • Just 17 months on from its inception, the Bank was working through 90 finance partners, supporting more than 48,000 businesses with a total stock of finance of £7.5bn.
     
  • Its role is to encourage the development of private sector solutions and enable the market to work properly, not compete with it.

3. Australia is one of the few advanced economies not to have a Credit Guarantee Scheme and does not see the need

The Productivity Commission finalised a report on Business Set-up, Transfer and Closure in December 2015 which carries a serious amount of weight in Canberra. It concluded that there was no problem in accessing business finance in Australia despite submissions to the contrary by many reputable bodies. Reasons given:

  • It simply involves a transference of risk from private lending institutions to taxpayers
  • There is little conclusive evidence that a CGS results in more business loans being made
  • The costs of setting up and maintaining a CGS are high
  • Despite not having a CGS, Australia’s entry rate for new businesses is higher or comparable to many countries that do — for example, Canada, Italy, Spain and the United States. 
     

Unfortunately, many of its conclusions were unhelpful for SMEs because of the required focus on starting and exiting businesses - their mandate ignored the obstacles faced by growing businesses. As a result, mid-sized businesses, the engine room of our economy, were not even considered: they provide 1 in 4 jobs in Australia and represent our best chance of achieving the Government's Jobs and Growth objectives.

“With a combined annual turnover of around $1.1 trillion, if Australia’s mid-size businesses were a state, their economy would be larger than Queensland”
— Greg Keith, CEO of advisory firm Grant Thornton in releasing their Australian Mid-Sized Business Report 2015.

Government funds should be invested alongside private sector funds to fix a clear market failure to finance the growth of established Australian businesses.

The most effective way to do this is set up one well-equipped agency to make it happen across Australia.