Growth capital

We need to change direction - our housing credit bubble is leaving business behind

Interesting article by Christopher Joye in the AFR today - see below - calling out our policy makers for spurring on our consumer credit bubble. Businesses are left behind.

It really matters that credit should be available for business purposes to finance growth. But our system allows banks to leverage house loans 40 times compared to 'only' 10 times for an SME loan.

So small-medium sized businesses that employ must of us don't get a look in...unless they own some real estate of course.


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  • Banks have effectively withdrawn from their original purpose: facilitate commerce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:

The RBA is blowing the mother of all bubbles

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

by Christopher Joye

With US employment growth again surprising forecasters and the jobless rate declining to a boom-time 4.7 per cent, below "full-employment", the question is whether central banks, and the Federal Reserve in particular, are "behind the curve".

In research this week Goldman Sachs assessed this using a framework previously advocated by Fed chair Janet Yellen. Goldman found "the Fed's current policy stance is about 1 percentage point easier than prescribed by a Taylor rule that uses a depressed neutral rate" and about 3 percentage points easier when adopting a more normal neutral cash rate of about 4 per cent. The latter assumption "implies that the current policy stance represents the largest dovish policy deviation since the 1970s", which coincided with an inflation break-out.

"The implication that current policy is somewhat 'too easy' is consistent with the fact the [US] financial conditions index remains easier than average and is still delivering a positive growth impulse at a time when the Fed is trying to impose deceleration," Goldmans said.

The investment bank warns "history counsels caution about falling behind" with the experience of the mid 1960s suggesting that inflation increases much more quickly at very low unemployment rates. Back then, years of benign inflation gave way to a sudden spike as the Fed wilted under political pressure not to aggressively tighten rates. A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966".

Federal Reserve Chair Janet Yellen: The third rate hike since the 2007-2009 recession was well telegraphed. Andrew Harnik

Could history repeat itself? Much hinges on policymakers' humility. Central bankers are not fond of acknowledging errors, often rationalising ex post facto via the meme that "this time is different", which can be exacerbated by the desire to propagate an image of infallibility. Remember the once-lionised monetary maven Alan Greenspan?

These risks have certainly spooked interest rate investors, although the adjustment process has a way to run. After the second biggest fall in fixed-rate (as opposed to floating-rate) bond prices in modern history in the December quarter, the spectre of a Fed hike in March - duly delivered this week - has lifted long-term rates further. 

Will RBA ever lift again?

In Australia the 10-year government bond yield is nearing 3 per cent, significantly higher than the sub-2 per cent level traders—gripped by "cheap money forever" fever—priced in September 2016. Current 10-year yields are, however, still miles below the 5.5 per cent average since the Reserve Bank of Australia started targeting inflation in 1993.

Some of the best interest rate traders I know, almost all of whom have never experienced a proper inflation cycle, genuinely believe the RBA "will never hike again".

The problem with a supercilious central bank is the ensuing risk insouciance increases the probability of mistakes. A classic example was a speech given by the RBA's new head of financial stability this week.

According to this revisionist narrative the global financial crisis (GFC) "hasn't fundamentally changed the way we think about financial system stability". The RBA is evidently so sensitive to allegations it has failed to heed the lessons of the GFC—by blowing the mother of all bubbles with excessively cheap money—that it felt compelled to repeat the mantra the crisis had not altered its approach on five separate occasions in the speech. There are demonstrable flaws in this fiction.

First, the RBA never came close to anticipating the GFC. Its financial stability guru, Luci Ellis, published a paper in 2006 arguing"the most important lesson to draw from recent international experience is that a run-up in housing prices and debt need not be dangerous for the macroeconomy, was probably inevitable, and might even be desirable".

Ellis maintained that "the experience of Australia and the UK seems to suggest booms in housing price growth can subside without themselves bringing about a macroeconomic downturn". Two years later the 33 per cent drop in US house prices would trigger the deepest global recession since the great depression.

Second, the GFC necessitated a raft of policy responses that had never been seriously contemplated before, which have transformed the way we think about dealing with shocks and the unanticipated consequences. Contrary to the recommendations of the 1997 financial system inquiry, the Commonwealth guaranteed bank deposits and bank bonds for the first time. The RBA agreed to buy securitised mortgage-backed portfolios via its liquidity facilities, which it had never done, and Treasury independently acquired $16 billion of these loans in the first case of local "quantitative easing".

Banks borrowed more money on longer terms from the RBA than anyone previously envisioned, which led the RBA to create a new bail-out program called the committed liquidity facility. In emergencies banks can now tap over $200 billion of cash instantly at a cost of just 1.9 per cent that makes trading while insolvent an impossibility.

A central tenet of pre-GFC regulation--attributable to the 1997 Wallis Inquiry—was that taxpayers should never guarantee any private firm for fear of inducing "moral hazard". This is the "heads bankers win, tails taxpayers lose" dysfunction that emerges when governments insure downside risk. The RBA has since conceded that the crisis bail-outs unleashed unprecedented moral hazards, such as too-big-to-fail institutions, that require new mitigants.

The Australian Prudential Regulation Authority used to allow the major banks to leverage their equity 65 times when lending against housing because these assets were presumed to be nearly risk-free. Since the 2014 financial system inquiry APRA has been persuaded to deleverage the major banks' home loan books to merely (!) 40 times.

In 2013 the RBA was publicly dismissive of foreign regulators' efforts to contain credit growth via so-called macroprudential interventions to cool hot housing markets. One and a half years later APRA belatedly sought to cauterise the housing boom the RBA's 2012 and 2013 rate cuts precipitated with light-touch macroprudential jaw-boning.

Of course in 2017 the RBA has a different version of events. Apparently it has always seen "macroprudential policy as part and parcel of the financial stability framework". It turns out that "in 2014 the Australian regulators [presciently!] took the [rear-]view that risks were building in the residential housing market that warranted attention".

Actually, none of APRA's December 2014 announcements had any impact until well into 2015 (two years after the boom started) and they proved to be woefully inadequate. This column revealed, for example, that many banks had completely ignored APRA's minimum serviceability tests on home loans.

Good risk management requires intellectual honesty, which is missing in action among those overseeing the "wonder down under".

Read more: 

Don't Bank on it! Tips on financing business growth

Established businesses that are expanding rapidly face challenges from all sides. They may be winning large contracts with slow-paying major customers, recruiting at a fast pace, experiencing increased competition and market pressures, they may need to invest in production, marketing and development almost simultaneously and the management team may also be looking at new ventures and territories.

If this sounds like you, then you will be familiar with the sensation of having to keep all the plates spinning, while also professionalising your business – perhaps taking on greater financial or managerial clout. You might be recruiting at director-level, while also cementing existing relationships with everyone from new recruits to your oldest customers.

As a thriving, established business, you have already established your credentials but to maintain growth, the business requires more working capital investment.

Most growing mid-sized businesses with revenue of $10-30 million could really do with another $1 million to fund growth. But where do you find it?

Raising equity from business angels does not make sense for most established businesses. Few owners are happy to give up control of their business. Similarly, few businesses fit the criteria of business angels who look for unique companies with strong growth potential and solid prospects for a sale of the business in the medium term.

At the other end of the spectrum is your bank. Unfortunately, banks require real estate security so it will be impossible to obtain meaningful working capital finance from a bank without pledging a substantial amount of real estate. Business owners waste a lot of valuable time looking for an overdraft from their bank.

Filling the void, peer-to-peer business loans can provide an alternative source of finance. These sources of funding are thriving but are typically only able to provide up to $150k on an unsecured basis. The costs are quite high and the need to repay monthly over a 6 month term makes even less sense for growing businesses.

However, there is another key option: your existing sales ledger can also provide a valuable source of cashflow with larger facility sizes ($1m+) than available from unsecured lenders.

Historically, the only option was factoring which involves onerous contracts and the consent of your customers. An ancient model, literally as it was invented around 4,000 years ago in Mesopotamia, it doesn't work for most businesses.

Now there is a much better way - confidential invoice trading. Online invoice trading platforms connect businesses with a pool of investors who will advance funds against existing valid invoices. Instead of waiting out long payment periods, businesses trade their invoices and receive a percentage of their value – around 80% - with a minimal waiting time. All without involving your customers.

Online or alternative invoice finance improves on the traditional approach to invoice finance and factoring considerably.

It is possible to trade a single invoice, rather than surrendering a complete sales ledger to a provider. The technology platform keeps costs low, and decisions on creditworthiness are rapid. Generally, platforms approve businesses within a day, provided they can produce bank statements and accounts. Once invoices are validated funds can be made available straightaway. Costs come in at around one to three per cent, but over time this kind of finance becomes more cost-effective, with discounts for subsequent invoices.

Invoice finance is a useful means of improving cash flow and unlocking access to working capital. It is also particularly helpful for businesses considering export markets where payment cycles can be unpredictable particularly in the short term.

Check out the alternatives to banks. Speak to a finance broker or your accountant or enquire directly with providers that seem to fit your needs.

Invoice trading is booming in Australia, according to a report by KMPG, University of Sydney, Cambridge University and Tsinghua Graduate School

As reported in The Australian today, in the first Asia-Pacific report surveying Alternative Finance published this week, it is notable that, relative to consumer lending, alternative business finance and, in particular invoice trading, has developed much more strongly in Australia than in the US and the UK.

We are quoted in the article as noting that this underlines the exceptionally under-served nature of the Australian small business lending market, which at the recent Altfi Summit in Sydney was estimated to be seeking an additional $95bn of finance.

This trend is also reflected in RBA lending statistics which show property loans since the GFC have grown by $538.7bn (+54%) while business lending has increased by just $72.5bn (+9%).

(RBA Statistics: Business Credit Seasonally Adjusted: $765.5bn in December 2008 to $838.0bn; Housing Credit (Owner Occupied and Investor) $992.9bn to $1,531.6bn)

KPMG’s endorsement of invoice trading will go a long way, but regulation is what really builds trust in a sector. The truth is, unlike consumer lending, a sandbox won’t accelerate the development of innovative new business finance products – but increased involvement from and endorsement by the gamekeeper will accelerate business adoption.

The government’s most pressing need now is to accelerate the adoption of alternative finance by SMEs, which would provide a kick-start to our economic growth. Introducing disclosure standards as to the cost of finance and terms and conditions of finance – similar to comparison rates for mortgages – is a simple step to take, but would dramatically change the reputation of the sector.

It’s clear that the regulatory environment needs a 21st century approach, and the government seems to be aware of this, but we are all waiting to see words turn into action. We’re in a similar position to when the SMSF market first emerged – the regulators had to rapidly come up with a new approach then, and the need is even more pressing now with the increased speed of the development of new business finance products.

As Paul Keating said: “When we laid the foundations for the current superannuation system in the 1991 Budget, I never expected Self Managed Super Funds (SMSFs) to become the largest segment of super. They were almost an afterthought added to the legislation as a replacement for defined benefit schemes.” 

Time to get wriggle on!



2 actions that Government can take to accelerate business growth

Yesterday, Australia saw the establishment of a government advisory panel on Fintech and the launch of a reform manifesto by Fintech Australia which we support.

We strongly believe that Government needs to become bolder in addressing market failure in providing our small-mid sized businesses with access to growth capital.

Here are two steps that could be taken this year:

  1. Build awareness of alternative financing options for SMEs to address market failure
    eg a mandatory referral obligation for banks declining credit applications
  2. Set up a Business Bank to: 
    • consolidate existing government funding mechanisms for SMEs in one place; and
    • provide modest co-investment support and endorsement for Alternative Finance providers

Working capital is the main impediment to growth, not equity.

Service businesses need working capital to grow and the current Basel III banking system cannot help in a meaningful way.

This is particularly true in the case of our critically important mid-sized companies:

Grant Thornton, December 2015:

According to the firm, mid-size business injects a combined annual turnover of $1.1 trillion into the Australia economy; contributing a further $241 billion through wages and salaries, employing more than 3.7 million Australians in the process.


There are interesting overseas examples, particularly in the UK.


The UK's major lenders will soon be required to share the financial information that they keep on small business to give these companies the best chance of securing loans.

The Government plans to force the banks to share their SME credit information with other lenders and to offer to share the details of SMEs rejected for a loan with online platforms that can match them to alternative finance providers.

The British Business Bank has also been tasked with "increasing and diversifying" the supply of finance available to SMEs. The Bank will facilitate up to £10bn of finance by 2019, according to new forecasts.




At present the largest four banks in the UK account for over 80% of UK SMEs’ main banking relationships. Many SMEs only approach the largest banks when seeking finance. Although a large number of these applications are rejected - in the case of first time SME borrowers the rejection rate is around 50% - a proportion of these are viable and are rejected simply because they don’t meet the risk profiles of the largest banks. There are often challenger banks and alternative finance providers with different business models that may be willing to lend to these SMEs.

Although the largest banks will sometimes refer these SMEs on (e.g. to brokers), in many cases challenger banks and other providers of finance are unable to offer finance as they are not aware of their existence and the SMEs are not aware of the existence of these alternative sources of finance. This is a market failure, of imperfect information, resulting in SMEs that are viable loan propositions not receiving the finance they need.

Why is invoice trading so different from conventional debtor finance?

We enjoyed reading a very useful article on Altfi recently which highlighted the leading invoice finance platforms in Australia.

Some important differences were highlighted:

First and foremost, it’s crucial to state the difference between invoice financing and invoice factoring, as they aren’t the same thing at all.

The former refers to borrowing money against businesses’ outstanding accounts receivables. An example helps to clarify the point. A lender gives entrepreneurs cash today in relation to the value of the company’s accounts receivables – money owed to the firm, which clients will pay in the future (hopefully). Once the clients pay up, entrepreneurs then repay the lender the amount loaned plus fees and interest.

The latter is a bit different. Indeed, in this case the lender “buys” the accounts receivables entrepreneurs are owed and takes over collecting from the clients. With invoice factoring, the lender will pay the business owner a percentage of the total outstanding invoice amount, then takes responsibility for collecting the full amount. Once they collect the full amount, they’ll advance entrepreneurs the difference, keeping a percentage for their services.

The main difference between these two forms of financing is obvious. In the first case, the business owner is still responsible for collecting outstanding money owed by his/her clients. In the second case, clients will deal with the factoring company to make their payment, not the business owner.

This usefully sets out some key foundations based on conventional debtor finance. During the early 1990s, 'invoice financing' or 'discounting' as described above developed into a major asset finance product for larger companies. In recent years, banks have steadily withdrawn from this segment due to the inherent risks and operational complexities.

Invoice finance is now seeing the development of a next generation product: confidential invoice trading. Over $2 billion of finance has been provided in this form in the UK alone, having started only 5 years ago.

This is a revolutionary new way of doing invoice finance, as pioneered by Marketinvoice in the UK since 2011 and adapted by InvoiceX for the Australian market since 2014. 

Confidential invoice trading opens up a broad market of high quality, growing businesses who are attracted to raising flexible growth capital confidentially on attractive terms. These companies are not attracted to factoring or invoice discounting.

  • Unlike factoring, our invoice trading solution is confidential. We are the only platform that offers this in Australia. We do not contact or chase the debtor for payment.
  • Unlike invoice discounting, our investors own the traded invoice. This is a much better place to be from a credit risk perspective. Our investors are not materially exposed to insolvency risk from the seller. Therefore, we can offer much better terms to SMEs and much larger facilities.

We are very excited as this form of finance opens up so many growth opportunities for many of Australia's most promising companies.

Why is invoice trading the smart way to grow and who offers it in Australia?

Great to see real progress this year in raising awareness of invoice trading. We operate the only confidential invoice trading platform in Australia. Our growing business customers love using our service and our investors are happy. That makes us happy too!

Spotlight On The Top 5 Australian Invoice Financing Platforms
By Guglielmo de Stefano on 18th February 2016

In a recent article, AltFi investigated what’s happening in the Alternative Finance Market in Australia. What emerged is that the AltFi revolution seems to have started approximately when Matt Symons and Greg Symons founded SocietyOne in 2012, the first fully compliant peer-to-peer lending business in the country.

That research focused mainly on peer-to-peer lending and equity crowdfunding. Although these two subsectors are key pillars of the broader alternative finance spectrum, we believe that invoice financing also deserves the same attention.

First and foremost, it’s crucial to state the difference between invoice financing and invoice factoring, as they aren’t the same thing at all.

The former refers to borrowing money against businesses’ outstanding accounts receivables. An example helps to clarify the point. A lender gives entrepreneurs cash today in relation to the value of the company’s accounts receivables – money owed to the firm, which clients will pay in the future (hopefully). Once the clients pay up, entrepreneurs then repay the lender the amount loaned plus fees and interest.

The latter is a bit different. Indeed, in this case the lender “buys” the accounts receivables entrepreneurs are owed and takes over collecting from the clients. With invoice factoring, the lender will pay the business owner a percentage of the total outstanding invoice amount, then takes responsibility for collecting the full amount. Once they collect the full amount, they’ll advance entrepreneurs the difference, keeping a percentage for their services.

The main difference between these two forms of financing is obvious. In the first case, the business owner is still responsible for collecting outstanding money owed by his/her clients. In the second case, clients will deal with the factoring company to make their payment, not the business owner.

In Australia, from what we can establish, the top 5 Australian invoice financing/factoring platforms are Waddle, Marketlend, Timelio, FundX and InvoiceX.

Waddle: Founded in July 2015 by Leigh Dunsford and Simon Creighton – owners of invoice factoring company Trade Advance – Waddle is an invoice financing platform, which has provided about 20 Australian SMEs with approximately $1 million in financing to date. In a recent interview, Leigh was keen to highlight that Waddle is no ordinary invoice factoring company. The platform offers a solution similar to factoring in some ways, but very different in others. As with factoring, Waddle provides funding against small businesses’ outstanding invoices. Unlike factoring solutions, businesses’ clients are never contacted or hassled by Waddle and entrepreneurs are able to skip on the paperwork headaches that historically plague the factoring process. 

Marketlend: Founded in December 2014 by Leo Tyndall and Paul Roffey, Marketlend was conceived as a business peer-to-peer lender, offering loans to businesses in the form of working capital, traditional business loans and commercial property finance. Its offering includes three products: a debtor finance product, an invoice financing solution and a trade finance service. In the case of invoice financing, loans are secured by a personal property interest over the borrower’s company and the platform owns the supplies as it pays for them; in the case of the debtor finance offering, they are secured against the borrower’s accounts receivable. To find out more about Marketlend click here.

FundX: Based in Sydney, FundX was founded by David Jackson – former Australian small business builder and investor. According to him, the primary aim of the company is to connect businesses with investors who can fund their cash flows. Users are provided rapid access to funds based on the value of their outstanding invoices. FundX uses big data, machine learning and predictive algorithms to analyse risk and authorise invoice funding “with the push of a button, in less than a minute”. 

InvoiceX: Founded by Dermot Crean and Steve Yannarakis, the company is strongly placed to help small and medium enterprises (regardless of their business sector) to deal with working capital pressures. Its primary product – the Match Maker Trading Platform – rapidly matches investors with businesses, optimising the deal for both parties. InvoiceX assures the total absence of set-up fees and a straightforward application process. The company aims to provide a cash advance – up to 85% of the Face Value of an invoice – within 24 hours.

Timelio: Founded in 2014, Timelio – formerly known as InvoiceBid – enables businesses to raise short-term finance by selling their unpaid invoices directly to a network of investors. The platform requires investors to fund their accounts with a minimum of $25k. Before being approved to sell invoices on the platform, all invoice sellers undergo a rigorous credit assessment. The platform states that third party analytics and searches might be used to further support the internal assessment. Before being made available for investment, each invoice and debtor will be verified and authenticated. Timelio has been recently awarded the “Game Changer of the Year Award” sponsored by Visa and the “Overall Award for Outstanding Excellence” sponsored by Optus at the OPTUS My Business Awards in Sydney. 

If you want to know more about the alternative finance space in Australasia, be sure to book your tickets for the AltFi Australasia Summit 2016 before they sell out.

CBA - why has non-mining capex not picked up? No reference to obstacles in raising finance to grow

For the past few years, economists and policymakers have assumed that a lift in non-mining business investment was forthcoming. A trawl through RBA documents and speeches shows that policy officials have been anticipating a lift in non-mining investment for a few years. And yet despite incredibly low interest rates and a significantly lower AUD, the lift remains elusive. It has felt a lot like waiting for Godot. Fortunately, however, there has been a greater than expected pickup in services activity which has generated a fall in the unemployment rate despite weak non-mining capex. This has supported the economy and employment growth over the past two years. But for the productive capacity of the economy to lift over the longer term, a lift in business investment outside of the resources sector.


In this note we ask the question why non-mining business investment has been so weak.


…it may be the case that expectations of future demand are too low to justify a lift in investment…

Capacity utilisation, as measured in the NAB Business survey, implies that throughout most of the past few years capacity utilisation in Australia has been below its long run average. This goes some way to explaining why business investment has been weak. And also why inflation has been low…

Australia’s manufacturing industry suffered greatly because of the first and second stages of the mining boom…

The problem, of course, for the manufacturing sector is that when the currency depreciates to more ‘normal’ levels, it’s not that easy to crank up manufacturing investment and output… the high fixed cost component of manufacturing means for firms that are forced to close, recommencing operations is often not an option…

[ScreenHunter_11560 Feb. 17 10.56]

The hurdle rate is too high. Firms generally use Discounted Cash Flow (DCF) analysis (or a version of it) to estimate the attractiveness of discretionary capital investment. But a range of evidence indicates that hurdle rates are often much higher than the weighted average cost of capital (WACC)…

The ‘stickiness’ of business hurdle rates is in stark contracts to valuation methods employed by property investors…The fall in borrowing rates over the past few years gave rise to a big increase in investor activity in the housing market. Dwelling prices rose quite sharply as interest rates fell…

[ScreenHunter_11561 Feb. 17 10.59]

Monetary policy has been overburdened for too long… Indeed, record low interest rates have been assumed to be the panacea to get non-mining investment going. But monetary policy can only do so much. The interest rate lever can help smooth out the business cycle. But it cannot do anything to change the more entrenched and structural impediments to growth which are primarily related to the inefficient allocation of resources.

In Australia, for example, policies should be developed that encourage and channel capital into projects that improve the productive capacity of the economy over the long run. Establishing an efficient taxation system that incentivises innovation and productive investment is one area that could help lift business investment…

Public infrastructure investment is also important. For example, greater investment in transport infrastructure will improve the productive capacity of the economy. And it supports private investment rather than crowding it out. At a time when the yield curve is at historic lows, there must be no shortage of viable projects where the costs of finance is less than the social rate of return…

[ScreenHunter_11562 Feb. 17 11.02]

Australian investors love dividends! And the pressure on companies to maintain or lift dividends in a low interest rate environment has intensified because deposit rates are so low. There is a risk that the pressure on companies to increase dividends has been paid for by cutting back on capital investment…

[ScreenHunter_11563 Feb. 17 11.03]

What can we expect in 2016?.. the leading indicators suggest that non-mining business investment growth is likely to remain weak over 2016. The latest capex survey suggested that non-mining capex would fall over 2015/16… [although] there are limitations with the capex survey…

Notwithstanding the soft capex survey, the latest credit aggregates offer a glimmer of hope on the outlook for non-mining investment. Business credit growth has been lifting which is an early sign of a lift in capital expenditure…

Grant Thornton leads calls for mid-size business minister - we totally agree. Critical driver of growth.

Good article in Accountants Daily. We think this sector deserves special attention, particularly given the declining appetite of banks to lend to businesses. We write about this subject a great deal and will keep writing!

The government can support the growth of its most powerful sector; Australian mid-size business, by establishing a Minister for Mid-Sized Business, according to the CEO of prominent mid-tier firm Grant Thornton.

Greg Keith, Grant Thornton Australia CEO, has led the push for the establishment of a Minister for Mid-Size Business in an attempt to bolster the middle market.

According to the firm, mid-size business injects a combined annual turnover of $1.1 trillion into the Australia economy; contributing a further $241 billion through wages and salaries, employing more than 3.7 million Australians in the process.

“As the engine room of our economy, we urge the Turnbull Government to incentivise mid-sized business. It’s time to appoint a Minister dedicated to fostering the growth needs of the sector and in turn boosting revenue growth for the Australian economy,” Mr Keith said.

“Despite their importance to the economy, mid-sized businesses are under-represented in the national debate. A Mid-Sized Business Minister is needed to develop specific incentive schemes to encourage growth and confidence where it will have the greatest impact,” he added.

Mr Keith also urged the government to establish a Strategic Development Fund, in the hopes of assisting mid-size business to break into the Asia Pacific market.
“This is an important initiative to encourage mid-size businesses to seek new revenue opportunities,” said Mr Keith.

In addition to initiatives to drive forward the mid-sized agenda, Mr Keith suggested that the concessions implemented for small business should be echoed for their mid-sized counterparts; such as a reduction in the company tax rate to 28.5 per cent and the immediate write off of new assets up to $20,000.”

“We would also like to see the Government extend some of its small business incentives to the more developed – and more likely to succeed – mid-size businesses, by extending the concessions to currently provided only to small companies.”

Why is funding for small businesses so severely constrained?

Most small businesses turn to bank financing to fund their operations. However, lending by banks is often limited because understanding small businesses requires more time and expertise than the more standardized consumer business.

At the same time, the traditional relationship-based corporate banking model is costly to operate in dealing with small business, given the smaller loan size. Further, information asymmetry as a result of the lack of supporting financial information infrastructure limits the ability to lend. Small businesses often lack the required data, such as a history of audited statements for a bank to appropriately assess its cash flow situation.

More generally, the high intrinsic risk of SMEs often exceeds banks’ risk appetite. This hesitation is further amplified by regulation, such as Basel III, which imposes higher capital requirements for (riskier) small business loans, compared to loans extended to states or home owners.

Over past years, banks have thus further decreased their lending exposure to SMEs while the costs of borrowing have increased for SMEs. In the US, SME loans as a percentage of all bank business loans fell from 35% to 24%. In the Eurozone, borrowing costs for SMEs as spread over larger loans increased by 150%.

The Future of FinTech: A Paradigm Shift in Small Business Finance, October 2015

SME finance in Australia is changing for the better thanks to P2P/marketplace lending

Oz P2P Lender Releases Loan Book

By Guglielmo de Stefano on 2nd February 2016

Invoice trading platform InvoiceX publishes its loan book as part of its plan to boost transparency.

Australian online invoice trading platform InvoiceX today announced the publication of its loan book, containing tons of data on more than $6.5 million of invoice trades from November 20th 2014 – when the platform launched – to 31 December 2015. According to the data, the company is on track to trade over $50 million worth of invoices in 2016.

Founded by Dermot Crean and Steve Yannarakis, the company is strongly placed to help small and medium enterprises (regardless of their business sector) to deal with working capital pressures. Its primary product – the Match Maker Trading Platform – rapidly matches investors with businesses, optimising the deal for both parties. InvoiceX assures the total absence of set-up fees and a straightforward application process. The company aims to provide a cash advance – up to 85% of the Face Value of an invoice – within 24 hours.

Dermot Crean, co-founder and director of InvoiceX, commented:

“Greater transparency is key to taking P2P lending mainstream, both for businesses and consumer loans. It is our hope that release of this data will prompt other P2P lenders to take the same action. We want to ensure that all business owners in Australia who are eager to grow have access to transparent and fair finance which puts the rights of borrowers at the centre of the lending process.”

Since inception, InvoiceX has facilitated 201 trades for SMEs with an average trade face value of $33,098, an average discount fee of 1.2 per cent per calendar month and an average settlement period of 35 days. The platform is keen on highlighting the differences between its business model and a normal factoring provider. Traditional factoring involves long lock-in periods, much higher costs and the losing of control of sales ledgers and collections. Conversely, InvoiceX’s product is totally confidential, with no lock-ins and a good deal of flexibility.

According to Dermot, the release of this data is indicative of a maturing P2P lending market in Australia. He said:

“The public release of this lending data will allow businesses to make easy comparisons between P2P lenders, and also directly with traditional finance options such as term loans and mortgages. […] Greater transparency is key to taking P2P lending mainstream, both for businesses and consumer loans. It is our hope that release of this data will prompt other P2P lenders to take the same action.”

It’s widely acknowledged that transparency is a key pillar of the Alternative Finance Space – essential to ensuring the sustainable growth of the asset class and to demonstrating that alternative finance platforms are behaving responsibly.

InvoiceX claims to be the first P2P Australasian platform to publish its loan book. “It's great to be the first to do this ever in Australian SME finance,” said Dermot. RateSetter Australia, following in the footsteps of its UK-based progenitor, uploaded its complete loan book online last October – although this resource is updated on a quarterly basis. On a global scale, many players have already disclosed their data, including the likes of ZopaFunding CircleRateSetter and MarketInvoice in the UK.

Aside from increasing the public’s opinion of the sector, data is critical also from a practical perspective, allowing for the construction of indices, such as the The Liberum AltFi Returns Index (LARI), which will likely come to form an essential component in the maturation of the sector.

AltFi Data today added an Australasian section to its Resources page, providing a link to the InvoiceX loan book, which is accessible here. We suspect that InvoiceX may have company in the Australasian section before long.

Interesting to contrast UK and US SME growth initiatives with ours - we need to take much bolder steps


UK Budget 2015

  • Corporation tax rate falling from 20% to 18% by 2020
  • Banks compelled to refer declined customers to alternative finance providers and share information
  • Government-backed Business Bank to facilitate up to $20bn of finance by 2019
  • $400k annual investment allowance
  • Enterprise Zones

US Small Business Administration

Created in 1953 as an independent agency of the federal government, its number one strategic goal is “growing businesses and creating jobs” and its second goal is to “serve as the voice for small business”.

The major tools employed by the SBA are a range of financial assistance programs for small businesses that may have trouble qualifying for a traditional bank loan. The biggest program is the 7(a) Loan Guarantee which guarantees as much as 85 per cent of loans up to $150k and 75 per cent of loans of more than $150k. The maximum loan SBA guarantees is $5m.

Loan terms can last up to 25 years for real estate, up to 10 years for equipment and up to seven years for working capital. The SBA limits the maximum interest rate banks can charge to no more than 2.75 per cent on top of the Prime Rate (currently 3.25 per cent). In addition, the SBA charges a guarantee fee ranging between 2 per cent and 3.75 per cent. So all up a small business would pay between 7.5 per cent and 9.5 per cent.

In 2015 the SBA approved 63,461 7(a) loans for a sum of $23.58b at an average of $371k. The total of all loans guaranteed was $111.769b with a bad debt rate (called charged off) of less than 1 per cent.


Budget 2015

We want to ensure Australia is the best place to start and grow a business. The best way to create jobs is to build a strong, prosperous economy that encourages business confidence:

  • Accelerated depreciation allowance of $20k (this is just a timing difference in when tax is payable and where do you find the capital anyway?)
  • Company tax rate for businesses with up to $2m of turnover will be reduced by 1.5 percentage points to 28.5 per cent

National Innovation and Science Agenda, December 2015

  • Tax breaks for angel investors
    The government will offer tax incentives for investors in startups including a 20% tax offset based on the amount of their investment capped at A$200,000 per investor, per year. There will also be a 10 year capital gains tax exemption for investments held for three years. This will apply to businesses have expenditure less than $1 million and income less than $200,000 in the previous income year.
  • Equity crowdfunding
    The government will introduce new laws to enable crowdsourced equity funding of public companies with a turnover and gross assets of less than A$5 million. Investments will be limited to a maximum amount of $10,000 per company, per year.

Why do growing companies fail?

Most growing companies in Australia are starved of cash, constantly running the gauntlet of paying payroll and keeping the Australian Tax Office and other creditors at bay. Why?

The insolvency statistics published by ASIC tell a sorry tale. In the latest report covering the 2013-14 financial year, 9,459 initial external administrator reports were filed with 22,606 nominated reasons for failure. The reasons given break down as follows:

Company failures FY14
Company failures FY14

So according to ASIC, at least 30% of companies in Australia failed during the 2013-14 financial year due to cashflow issues.

In our experience and speaking to experts, most growing businesses underestimate how much permanent capital they need to raise to fund their growing book of unpaid sales invoices.

Rapid growth and the extra demands it places on working capital usually puts businesses under cash flow pressure. It's mathematically certain unless you're in a business where your customers pre-pay for what you sell them!

In some cases businesses struggle through, in others they fall over in the growth phase. It is important to understand that you cannot grow without planning on how you will fund the growth. Generating profits to fund it on your own will take too long.

Before aiming for growth in your business, you need to understand and address several issues, including:

  • Cash flow optimisation - very important in the short and long term. You need to understand:
    • Your cash flow cycle
    • The demands of extra trading stock
    • The impact of increasing debtors
    • The effect and timing of your basic operating costs.
    • Cash flow forecasting - essential for any well run business, this involves developing realistic projections for your operational budgets. Sensitivity analysis will help you forecast the impact of errors (10%, 20% or 30%) in your assumptions.
    • Capital management - start by identifying how much capital the business needs and how much is being provided by the available sources. Your business is only funded from capital, debt, and retained profits and in the early days of the business there are no retained profits, so it comes down to capital and debt.

From the start there is a continuing requirement for capital management. This is about understanding:

  • The initial requirements or establishment costs of the business
  • Additional capital that will be required to fund growth
  • The timing and amount required to replace or upgrade capital equipment
  • Funding required to repay loans and retire debt
  • Taxation requirements
  • The expectations of the shareholders for access to profits

None of these items appear in the operating budgets of your business, yet each of these draw cash from the business. You could have a profitable business and be cash flow positive from operations, yet be under significant cash flow pressure. If you want to grow your business successfully, then a capital management plan must be regularly reviewed and a capital expenditure budget should be prepared each year.

Our Growth Check-Up Tool highlights how much more cash becomes tied up in your invoices as you grow - cash that you will need to pay suppliers and cover other operating costs.

SME business lending: the trend in favour of P2P lending is clear #ideasboom

Basel III regulatory capital rules favour mortgages 4x more than business lending so the trend in favour of P2P lending is clear:

  • SME bank loans represented only 15% of new business loans in Australia last year (Source: RBA)
  • SME loans by US major banks have fallen by 40% since 2006 (Source: Wall Street Journal)
  • Bank lending to London’s SMEs plummeted 40% in the last year but an estimated £350m of SME finance was completed through peer-to-peer lending in 2015 (Source: British Bankers’ Association).   

P2P finance has “the potential to become a game changer for small businesses and brokers. Because FinTech solutions are efficient and effective at lower scale, small businesses will be one of the main beneficiaries of FinTech’s disruptive power.” World Economic Forum Report, October 2015

Lending Club paves way for rivals: low cost is the critical success factor

An interesting article in the Financial Times analysing the bumpy ride for Lending Club, the leading US P2P lender, in its first year post-IPO. Like Amazon, offering the lowest cost is key to success.

January 26, 2016 11:15 am

Lending Club paves way for rivals

Ben McLannahan in New York

Larry Summers was effusive, when asked in December 2014 to comment on the stock market debut of Lending Club. Shares in the San Francisco-based group leapt more than 50 per cent on day one on the New York Stock Exchange, as investors scrambled to get exposure to a branchless lender that had vowed to “transform” the banking system.

“It’s a good day for Lending Club,” said the former US Treasury Secretary, part of an all-star board of directors assembled by the company, which connects people seeking money with people willing to lend. “It’s not the beginning of the end, but it is perhaps the end of the beginning.”

But in the 13 months since, the revolution has not yet come to pass. Although Lending Club has grown strongly, more than doubling revenues last year while pumping out billions of dollars of personal loans, the stock has mostly fallen amid fears of rising competition and tougher regulation. And far from displacing the old bricks-and-mortar banks, Lending Club appears to have galvanised them into action, spurring copycat services and all manner of alliances between traditional lenders and the upstarts.

Mr Summers himself has been a seller of the stock, offloading about 120,000 of his 1m shares since September, according to public disclosures logged by Bloomberg. A spokesperson said that Mr Summers has a “substantial concentration of his net worth” in the stock, so “made a decision when the company went public to diversify and established a regular selling programme”.

So poorly have Lending Club’s shares performed, in fact — down 56 per cent last year, and another 28 per cent this year — that other online lenders such as Prosper and SoFi appear to have cooled on the prospects of going public.

Underwriters sold Lending Club as if it were a web platform in a similar vein to LinkedIn, Facebook or Alibaba, said one Wall Street banker, speaking on condition of anonymity. “The reality is that it trades more like a bank.”

Michael Tarkan, a Washington, DC-based analyst at Compass Point, argues that intense competition and an “inhospitable” policy environment will continue to weigh on the shares.

Lending Club and its instalment-lending peers are facing new levels of oversight by the Consumer Financial Protection Bureau, beginning later this year, for example, and a sector-wide probe into pricing and credit quality by the California Department of Business Oversight, due to complete in March. And later this week federal lawmakers are due to start debating laws on terrorism financing — an effort that could result in extra scrutiny for online lenders, given that one of the killers in December’s shootings in San Bernardino had taken a big loan from Prosper.

Meanwhile, regional banks such as Citizens and SunTrust have pushed more deeply into personal loans, while non-banks such as are moving on to Lending Club’s core patch of debt consolidation. Even Goldman Sachs, the New York investment bank, is preparing to launch a consumer-focused online venture.

A survey by the Office of the Comptroller of the Currency last month found that banks expected the risk profile of their personal loan portfolios to rise this year by the largest amount since 1998 (excluding the crisis) — implying a direct assault on the web-based lenders.

“Lending Club is offering a commoditised loan product,” said Chris Gamaitoni, an analyst at Autonomous Research. “We don’t see a moat that cannot be attacked by large peers.”

Renaud Laplanche, Lending Club’s co-founder and chief executive, told the Financial Times that increased regulatory interest in online lending does not imply a crackdown on the sector, and argued that the company has beaten back waves of challengers since its founding nine years ago.

As for the stock price, he said that it is only a matter of time before sentiment turns. He noted that it took about a year for Facebook stock to start to climb after the company’s initial public offering in May 2012.

In the meantime, he added, an imminent announcement of entry into a new product area, perhaps car loans, could rekindle some excitement. He hinted the move could be taken in conjunction with one of the traditional banks — similar to JPMorgan Chase’s tie-up last month with OnDeck Capital, a specialist in lending to small businesses.

That deal was seen as an admission from the biggest US bank by assets that it could not issue or service loans as cheaply and as efficiently as OnDeck, an online lender. But equally, it was a sign that OnDeck needed the customer connections and the steady funding of Chase, the bank’s huge retail network. Since signing the partnership early last month, OnDeck’s stock has steadied, outperforming the financials sector.

“Think of the cost of credit, which is basically the cost of operations plus the cost of capital; Lending Club has the lowest possible cost of operations, with technology and automation, and banks have very low cost of capital,” said Mr Laplanche. “I think the partnerships between marketplace lenders and banks make tons of sense.”

SMEs account for only 15% of new lending

Article in today's Australian by Michael Bennett


Banks vie for credit growth as non-mining sector picks up

The nation’s biggest banks are jostling for a bigger slice of the business lending market as analysts tip a solid year of credit growth as the non-mining parts of the economy improve.

After two months of healthy demand, business credit growth flatlined in November, dragging down annual growth to 6.2 per cent, from 6.6 per cent, according to latest Reserve Bank data.

But apart from October and September, 6.2 per cent remains the strongest since February 2009 and economists expect the revival in recent months hasn’t petered out.

Even so, the latest figures compare to the peak in December 2007 of 24 per cent, the strongest since the prior boom in December 1988. In contrast, demand bottomed in November 2009 at negative 7.5 per cent and remained muted until recently.

Our perspective:

Per the RBA, as at Sept 2015 and published on 17 Dec, total business lending was up a healthy 9.6% to $857bn.

85% of the $75bn growth was in loans over $2m which totalled $596bn as at 30 Sept.

Of the $75bn in growth, 40% came from 'Other' industries.

Finance and insurance accounted for 25%, Wholesale trade, retail and transport 18%, Construction 6%, Manufacturing 10%, Mining 0%, Agriculture 1%.

Lending in the critical $500k - $2m bracket - ie SMEs - grew by 5.1%. How much of all of this was mortgage lending? We do not know.

Basel III regulatory capital rules favour mortgages 4x more than business lending. As a result, our banks behave like building societies - understandably.

The Fintech sector can fill the gap but it needs to become much bigger to move the needle on growth.



Why the UK Gov is fully engaged with Peer-to-Peer Lending - Financial Times

Treasury sings praises of peer to peer lenders

City minister Harriett Baldwin has branded peer to peer lending a “brilliantly innovative new form of finance – which we want to see continue to grow and evolve.”

In a speech to the Peer-to-Peer Finance Association (P2PFA) Summit in London yesterday (21 October), Ms Baldwin said peer-to-peer lending can plug the funding gap for small businesses.

Ms Baldwin said: “I am proud of the fact that the UK has the largest P2P and alternative finance sector in Europe. We’ve worked hard for that.

“We knew, for example, that for the sector to mature, it would be important to bring it within the correct statutory framework. Proportionate regulation will protect consumers lending and borrowing via a P2P platform and allow the sector to continue to grow.

“P2P platforms and fintech provide competition, ideas, and technology– making people’s lives better and the markets more effective. When you do well, your businesses flourish. Excellence breeds excellence.

“Customers have the services they need to meet their aspirations. And this country becomes better off, as a result of all this activity taking place here in the UK. We are ambitious, because you are ambitious too. I can sense the energy in this room.

“The businesses here – from Funding Circle to RateSetter to Zopa – are some of the most innovative in Europe.”

The MP for West Worcestershire highlighted the fact as part of the savings package announced in the March 2015 Budget, the Conservatives confirmed they would expand the range of products that can be held in stocks and shares Isas to include loans made through P2P platforms.

Holding P2P loans within an Isa will mean that interest received on the loans will not be subject to tax. These rules will come into force from the start of the next tax year, on 6 April 2016.

From earlier this year, investors in P2P platforms have also been allowed to offset any losses from P2P loans which go bad against other P2P income, reducing the amount of income tax that the individual has to pay on the P2P interest.

Ms Baldwin said: “The objective here is to level the playing field, and make P2P more attractive to investors by equalising the advantage banks and other investment products have over them.

“We have also been consulting with industry on the implementation of new withholding tax obligations, to apply across all P2P lending platforms from April 2017.

“I appreciate the engagement this sector has had with the government on this issue, and we will be publishing our response soon – watch this space.”

Ms Baldwin’s gushing praise for P2P came after new research revealed that 40 per cent of people would consider investing in peer to peer when the Innovation Isa launches next April.

A survey conducted by One Poll among 500 active investors by lending platform ThinCats found that the new Isa will expand the market by as much as a third, as investors seek to utilise the tax advantages available to them.

During her speech Ms Baldwin also talked about pension freedoms and said what we will be seeing over the coming years is a fresh wave of customers who are much better-informed, and much keener to exercise these new powers – not least, through investing.

Ms Baldwin said: “A real opportunity for the financial services sector to deliver for them.”


The Uber and Airbnb of Confidential Growth Capital - the Smart Way to Grow

invoice finance re-inventedMaking sense of the business finance market

The first thing to know about how we work is that we are in the business of matching high quality, growth companies with a strong network of investors but only as and when needed and always on the very best terms that can be found.

This is unusual. We are creating a new category of growth capital based on substantial experience of working with highly successful companies.

Why are our terms the very best on offer?

We do not compete with banks. Bank finance is secured on property ('fixed assets') so it is always going to be the lowest cost finance but it is not comparable. It’s basically a more expensive mortgage than a typical residential mortgage. Or it could be equipment/vehicle leasing from a bank or other large finance provider. When you’ve exhausted this option, where can you go for real growth capital?

Equity investors, if you can attract them, will need a big say in how you run your business and will need an exit route ie sale of your business. And a great return for the risk and complexity.

We are plugging the very large gap between banks and equity investors.

Our terms are transparent and straightforward to understand. They get better the more you trade with us.

Any other options?

The only other option is conventional invoice finance – disclosed factoring is the most common product offered to small businesses. This typically involves onerous 12-18 month lock-ins, minimum monthly fees and hidden fees, especially on termination. Their best rates are only available to those that undertake to sell all of their invoices to the factor. And your customers will know all about it. This is usually not attractive to higher quality growth companies with large customers. For larger companies, there are confidential options but again you will need to lock into an exclusive, whole book arrangement with onerous termination provisions – this is usually more than you need most of the time and therefore overly costly.

The headline rates for conventional invoice finance can look attractive but the devil is in the detail. We do not operate that way – our fees are easy to understand and, based on experience, much better value than any other provider. And it’s truly confidential.

We realise that this can be confusing. Just call us and we will be very happy to have a relaxed, ‘non-pushy’ chat about why our customers love our product. If you’re still not sure, we are very happy to speak to your accountant or adviser as we are very transparent and keen to establish a trusted relationship. That’s why we do not lock-in our customers.

Basel III, SME lending and the grave errors of risk weighting - insightful report by global accountancy group

ACCAReport by ACCA (the Association of Chartered Certified Accountants), the global body for professional accountants with over  140,000 members, 404,000 students and more than 8,000 Approved Employers in 170 countries - published in 2012 but worth re-reading as the report correctly foreshadowed the impact on SME finance worldwide

The focus of Basel III, and indeed of all capital regulation so far, is not primarily a bank’s balance sheet but the sum of its risk-weighted assets. Capital adequacy rules assign a risk weighting to each of a bank’s assets that is meant to be proportionate to the credit and market risk that the asset in question represents.

Under Basel III, loans to SMEs are assigned a relatively high risk weighting, inherited from Basel II, which should, when combined with rising capital requirements and turbulent capital markets, result in a disproportionately high cost of capital for banks when lending to such businesses and a gradual shift of their entire business models away from SME lending. Moreover, the evidence reviewed by ACCA (2011b) suggests that capital set aside against SME loans has, in the past, significantly exceeded any losses from defaults.

Basel’s approach to risk weighting is based on a significant misconception regarding the purpose of capital regulation. Risk weightings incorporate rough estimates of credit, market and operational risk (Blundell Wignall and Atkinson 2010). It is not, however, the purpose of capital regulation to protect individual banks from bad debt, poor investments or flawed internal controls. Financial institutions have substantial risk management functions and governance arrangements charged with this task and can generally monitor their exposure better and more regularly than regulators can. Regulators should, of course, review these functions and arrangements and will no doubt find much in need of improvement. But the purpose of capital regulation is to protect the wider financial system and the taxpayer from the banks’ flawed incentives.

Capital regulation, like all regulation, is only justified insofar as it addresses market failure. In the case of financial intermediaries it has been amply demonstrated by the financial crisis of 2008–9 that negative externalities do exist and that avoiding these does justify some kind of capital regulation. Through their actions, financial intermediaries expose their counterparties to systemic risk without bearing the social cost of this by-product of their activities. The result is an excessive accumulation of systemic risk, which is the proper province of capital regulation.

This distinction means that inferring ‘optimal’ risk weights from past or forecast default rates is a deeply flawed methodology because it conflates risks that should be the target of regulation with risks that should not. Both internal risk models (whereby the banks assign their own risk weightings according to internal risk calculations) and standardised risk coefficients (provided by Basel and the implementing regulators) are based on this principle and are thus equally problematic.

To illustrate: for a bank, giving a three-year €1m loan to an SME is doubtless much riskier than buying €1m worth of newly issued three-year AAA-rated government bonds. Statistically, some of the SME creditor population must default in a given year, while the AAA-rated sovereign is certain, for all intents and purposes, to survive and pay off its creditors. Hence a narrow view of risk will rightly consider the SME to warrant a much greater capital allocation. In fact, there is more to this story than this narrow view.

Unlike the SME loan, the bond can be posted as collateral many times over in the wider financial system (2.4 times on average, based on the estimated global velocity of collateral), enabling a disproportionate volume of transactions (Singh 2011). Its price will correlate strongly with those of a host of other assets to which the bank is exposed, and can be subject to unstable feedback loops involving these (BIS 2011); and because bonds are publicly traded, its value will change constantly and may do so at any instant.

To be fair, SME loans are not free from systemic influences (Direr 2002), particularly in sectors that rely heavily on trade credit. But the two assets’ systemic footprints (to borrow from the literature on another negative externality) hardly compare.

Put another way, nearly all the risk involved in an SME loan is borne by the lender as straightforward credit risk, and most of the rest is borne by the business owners as straightforward financial risk. In the case of the bond, however, the risks are more diverse and diffuse, and in buying, holding or trading the bond the bank has internalised only a tiny amount of these. This begs the question of how risk weightings can be corrected to reflect the kinds of risk that Basel should be targeting.

Given the sheer amount of political will invested in it, a wholesale review of Basel III is most unlikely, but a recalibration within the current framework may be possible. In fact, the Basel Committee has already demonstrated one approach to this in its search for ‘global systemically important financial institutions’ (BCBS 2011). That assessment set out to identify institutions that are Too Big or Too Interconnected To Fail through a set of criteria: cross-jurisdictional activity, size, substitutability and complexity.

A similar approach can be used to calibrate the existing risk weights, by asking the following questions.

• To what extent are assets traded between financial institutions, especially internationally?

• What share of the financial institution’s assets and revenues does the asset class represent?

• What share of total activity in the asset class does this institution represent?

• How complex is the asset in question?

This process could be used to derive systemic risk weights complementary to the credit, operational and market-risk weights already employed by Basel III. This would result in weights that are not only more conducive to SME lending but also more consistent with the purpose of capital regulation.