Fixing our business banking system is the most effective way to get our economy growing
Insights from the CPA's recent SME Finance roundtable in Melbourne
Recently, in a packed room of CPA members in Melbourne, I had the pleasure of participating as part of a panel discussion on the exciting changes sweeping the market for mid-market finance, and how new forms of finance are powering this engine room of our economy.
With over 50 different new online lenders, this new breed of financier are providing everything from quick turn-around loans to working capital finance and equipment finance, and branded as everything from ‘FinTech’ to ‘marketplace’ or ‘peer-to-peer’ lenders. The question on everyone’s lips as they arrived was ‘what do they have to offer to mid-sized businesses?’
What we easily agreed was that where online lenders really excel for the mid-market is in their ability to finance unconventional products in unconventional ways. For example, in providing confidential invoice trading facilities, InvoiceX is able to finance accounts receivable on an invoice-by-invoice basis, allowing clients to control their financing costs in real time. As a result, mid-market companies can avoid signing up to onerous contracts associated with invoice factoring where you would typically sign over all of your accounts receivable on a disclosed basis for a year or more.
However, as all of the participants quickly realised, even though the financing process is conducted through the internet more quickly and easily and leverages different forms of security and collateralisation than conventional lending, traditional barriers to access still remain – including the dreaded ‘credit check.’
But this credit check doesn’t need to be dreaded – with a couple of simple steps, you can avoid creating a negative credit picture with the credit bureaux.
Under the Comprehensive Credit Reporting (CCR) reforms introduced in 2014, banks and other lenders are supposed to share positive credit data, but progress and uptake of positive reporting has been very slow. That’s a pity because it would give a fuller and fairer picture of the credit applicant’s financial health, enabling a positive assessment for good recent credit performance (for example no missed payments in the last 24 months) rather than potentially being denied credit because of a low-value default many years ago. As it stands today, only negative data is available.
It is not widely appreciated that shopping for credit can lead to what is referred to as a high ‘inquiry pattern’ by the credit bureaux. This can have a more detrimental impact on your credit score than their paying more than half of your accounts payable between 1-30 days late.
Fortunately, through speaking with your advisors, you can ensure you’re avoiding this problem by selecting the right credit provider before applying. By engaging them early in the credit application process to build an accurate credit picture and approaching the most appropriate providers for a decision in principle before formally applying for finance, you can minimise the resultant hit to your credit score.
With these easy steps you can protect your credit score and over the longer term improve it to access cheaper sources of finance.
Go on, have a chat with your advisor today and get your credit score lean and ready for summer business.
Every business should have a contingency plan to deal with an unexpected dip in cash flow. While simply having a business overdraft available provides some degree of short-term protection, it’s best to have an array of lifelines at your disposal. Also, we find that the overdraft gets used for everyday purposes rather than for unexpected problems.
Peer-to-peer financing is another clever route to addressing temporary dips in cash flow. Conventional peer-to-peer financing involves online companies lending to businesses from funds gathered through a pool of investors. These loans are usually quicker and more straightforward than conventional borrowing and there is no minimum amount, so they are perfect for topping up cash flow. Beware: some offer much better value than others: don't be taken in by headline rates, do some calculations or check with your accountant.
Another smart take on peer-to-peer financing is an online improvement on invoice ‘factoring’, whereby a business in need of cash sells its ledger to a bank or another conventional lender. The online providers in this area of peer-to-peer financing, which include InvoiceX, will buy (for 1.5-3% per month) individual invoices – allowing companies to easily draw specific, limited amounts – but avoid the hidden fees, long contracts and slow decision processes of traditional factoring providers. For working capital spikes, this is often a better ongoing solution than a short term loan which can cause more cashflow problems a few months later. Importantly, watch out for whether your customer needs to be notified.
Insightful analysis by Alan Kohler in The Australian this weekend on what is holding business back and the negative effects on our economy. Sadly, our politicians seem to be disconnected from the reality of how to manage our economy.
"A small business tax break is worthwhile perhaps, and likewise an RBA rate cut, and in each case it’s really all the government and the central bank can do."
The Government could get involved investing modest sums on alternative finance platforms, like the UK Government did 3 years ago with powerful positive effects (and good returns on investment).
That would help overcome people's natural caution and skepticism. People tend to think that banks have some super-natural powers in deciding who is creditworthy. Overseas' experience makes it clear that they are simply expensive, bureaucratic building societies that have lost their way.
My father was a bank manager and retired when the computer took away his discretion. Bank managers in his days had real discretion and could support businesses with their growth plans. We need to re-invent banking by going back to why they came into existence in the first place. It had nothing to do with household mortgages which simply inflated the price of unproductive assets.
Here's a more detailed extract from Alan's article:
APRA, in line with global bank regulators, has also told them to increase their capital ratios, and since the system of risk-weighting means that only a quarter of the value of a real estate mortgage is counted against capital versus 100 per cent of a loan secured only against a business, that means all lending these days is more or less confined to mortgages.
It means the banks are basically not lending to those who don’t own a house or are already fully committed on their mortgages, and those who are building houses for investors.
So they are going elsewhere and paying 10-15 per cent more in interest than the banks would charge, except they’re not.
It means the divide between the haves and have-nots (a house, that is) has never been this great, and it’s also why this week’s rate cut by the Reserve Bank will make no difference and why the government’s efforts in the budget to help small businesses and middle income earners will only scratch the surface.
Banks actually run the economy by both creating money and circulating it, not the RBA or the government, and these days banks are only serving those who have equity in real estate.
According to economist Saul Eslake, home ownership rates among households headed by people aged 25 to 55 have dropped by an average of 9 per cent since 1991.
Most dramatically, the rate of home ownership among 25-34 year olds has fallen from 61 per cent in 1981 to 47 per cent in the latest census.
That is a huge social change: in one generation the number of families starting out and having children who also own their own home has dropped from almost two-thirds to less than half, and in the past 10 years the decline is accelerating.
It means the number of young people able to get a bank loan to start or expand a business, or to get a car loan or personal loan for anything less than 15 per cent interest, has also fallen significantly.
And a lot of that change is caused by the real estate market distortion inherent in negative gearing and the capital gains tax discount, which rewards highly geared property investors at the expense of owner-occupiers, who are in turn paying higher taxes than they otherwise would be in order to fund the subsidy to property investors.
So the combination of high house prices caused, in part, by negative gearing and the capital gains discount, with the transformation of banks into little more than building societies that lend almost exclusively against real estate, is the reason growth is weak.
A small business tax break is worthwhile perhaps, and likewise an RBA rate cut, and in each case it’s really all the government and the central bank can do.
But what’s really crimping entrepreneurship and growth is the post-GFC change to banking.
It means business people looking to expand have to come to Shylocks like your correspondent.
Most don’t bother.
Budget 2016: $90m of our money will be spent on workshops for the government to teach entrepreneurs! And tell them how to get a tiny handout. Unbelievable waste!
$10m of that money on our platform would go around 10 times in the next 12 months and help seasoned business people do a $100m more business right now.
According to the Australian Private Equity & Venture Capital Association - AVCAL - Australia has around 30,000 businesses which fall within the private equity ‘investment range’ (i.e. businesses that have growth potential and which are likely to require significant capital injections to realise that potential) (see Figure 2).
Many of those businesses will, at some point in the medium-term, seek investors for a variety of reasons such as succession planning, expansion capital, and turnaround financing.
PE funds are currently invested in fewer than 350 businesses in Australia: meaning that they presently have the funding capacity to financially back less than 2% of the total ‘investable pool’ of up to 30,000 businesses.
Combined with the regulatory capital constraints imposed on SME bank lending, accessing finance for growing businesses in Australia has rarely been tougher.
Another week, another story about transitioning from the mining boom. Australian service businesses have a great deal to offer overseas companies. We see it every day. But without the finance to grow, how can you do it? Has anyone asked that question in Canberra?
Our broken Basel 2-3-4 system of regulatory capital makes our banks focus on residential mortgages, not lending to businesses. Time to change that. Now!
"Sheep, iron mine and Sydney Opera House," writes Yongyu Ma, a student, on the online forum Quora in response to the question "What do Chinese people think of Australia?"
Prime Minister Malcolm Turnbull this week headed a 1000-strong delegation of business people to China in an attempt to convince them we have more to offer.
Events and banquets were held across 12 Chinese cities, with Austrade officials acting as cupids, of sorts, setting up speed dating sessions for Australian businesses to tout the full diversity of our economic wares to Chinese buyers.
This report is based on a survey of over 500 alternative finance platforms in 17 Asia Pacific countries and regions, capturing an estimated 70 percent of the visible market. As the first comprehensive study of the Asia-Pacific online alternative finance market, this research contributes to the growing body of data supporting the region’s potential.
16 March 2016
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]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/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]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/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]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-investment/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]http://www.macrobusiness.com.au/2016/02/the-illusive-future-boom-in-non-mining-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…
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.
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.