The royal commission, over the preceding weeks, has taken a great deal of time to look at the issue of bank lending to SMEs. Accompanying its many hours of deliberation, the press narrative has dedicated column inches to whether or not there should be greater regulations in this regard. They are not alone.
Successive governments, aware of how crucial the SME space is to the economy, have politicised the issue ad nauseam. In its overhaul of consumer lending regulations under the National Consumer Credit Protection Act 2009 (NCCP Act), the Labor government tried to draw small business lending into the mix. Though the NCCP was laudable, it is a good thing that the members of the Industry Advisory Group (of which Semper was an enthusiastic member) were successful in resisting it. The Labor government of the time, the Liberal government that followed and every SME in the country are no doubt grateful of the outcome: being able to thrive, without unnecessary lending restriction.
Simply put, ANY increase in regulations that result in limiting the rights in default of lenders providing loans to small business is going to have an adverse effect on lending to small businesses. 97 per cent of all businesses fall into the category of “small business”, and according to the Australian Bureau of Statistics, 60 per cent of them cease operating within the first three years; of these, 44 per cent closed shop because they suffer poor strategic management and 33 per cent through trading losses.
Almost all small businesses will seek to borrow money at some point, and almost every one of them will expect to achieve a positive outcome from so doing. If they fail, do we place fault on the lender? Perhaps if the loan proved to have been provided recklessly and without considerations for the cost to the business or its ability to repay, then the answer might be yes. Otherwise, it is a basic tenet of contracts that the entity most likely to be able to control the risk, should bear the risk. This responsibility — rarely, if ever — falls on the lender.
Because of the high rate of small business failures, banks prefer to see strong trading figures demonstrated by management accounts, together with well-thought-through projections for the employment of borrowed funds. Small businesses may not always have these and fall back on real property secured borrowings by which to raise capital. Perhaps it is because of the dichotomy between lender and borrower which causes the weakest to pay higher interest and fees that there is a deep-seated mistrust that drives the socialist-minded to cry foul. But we do not seem to complain when a smoker pays more for life insurance than a non-smoker?
During NCCP Phase II, debate rested on the risk to borrowers using equity in their home or other real properties and whether or not the government should take steps to protect it. The Industry Advisory Group argued that it should be every person’s inalienable right to use equity in a property as security against a business borrowing. It was also argued that the cost of restricting lenders’ abilities to recover against an asset in the event of default would be borne by all borrowers or that such restrictions would vastly reduce the appetite of lenders to lend.
We have experience in this regard: the debacle that was the non-democratic and unconstitutional structure of former financial ombudsman services caused unnecessary delays and failures in disputes that added untold costs to consumer and business borrowing. These services have now been replaced by the Small Business Ombudsman (with the unfortunate acronym ASBFEO), headed by Kate Carnell.
What spurred the debate on rapidly, however, was the question posed to the Industry Advisory Group by the government when it asked, “Are there any differences between a consumer loan and a commercial loan, and if so, what are they?” The question was clearly aimed at dragging SME lending into the NCCP framework and the consequences of it potentially dire. This required a considered response, which is noted below:
“Consumer lending, as the title suggests, is ‘consumptive’. It consists of the raising of a loan with interest, to buy goods today that cannot be afforded until tomorrow. The goods are consumable and of little or no productive value. The purchase is driven by desire rather than need.
“Commercial lending involves the raising of a loan with interest by an income-producing entity to raise cash flow and/or liquidity to increase productivity or temporarily preserve value. Commercial loans are productive and/or preservative, but never consumptive.”
As explained, the absorption of SME loans into the NCCP Act was prevented. But this is why it was so dangerous: had it been taken into the NCCP Act, Regulatory Guide 209 would have applied to small business lending and this set indeterminate conditions for “responsible lending” which required a lender to assess a borrower’s capacity “to comply with their financial obligations under the contract”. This is fair enough where the credit process for assessing affordability for a consumer rests simply on its income at the time of borrowing.
But to apply RG 209 to small business lending misses the point that small businesses borrow money to grow by creating increases in revenue, which in turn increase future profits. But under RG 209, a lender would have to make an assumption on the likely future success, post-loan, in order to prove the capacity of the borrower to meet obligations under the loan contract. And this is very much more difficult. This could make the lender adopt the position as shadow director with all the responsibility and yet no authority and render it liable for punitive, if not criminal, charges. A potentially crazy situation.
Would this have improved the lot for SMEs? No. It would have resulted in a rapid reduction in appetite for SME loans. As a result of our measured resistance, the government was stopped from regulatory overreach, but with banks weakening and at a risk of losing business rapidly to more agile, more transparent, businesses using technology to achieve economies of scale, you can rest assured it will not be long before the government revisit regulations, particularly those over the non-bank sector (and not necessarily to benefit the end user but more likely to protect the banking system itself).
As short-lived as any protection might be, like Uber in the world of taxis, change is coming. It will be the meteor that strikes the dinosaurs the banks represent. But while this disruption occurs, there are things that brokers and accountants can do to prepare the interests of their SME borrowing clients. These include:
- Clearly explain what the funds will be used for when applying for any loan
- Describe accurately how the business is structured and what is the distribution of value
- Be transparent with all assets
- Provide projections that predict the outcomes after employment of new capital
- Show/explain how cash flows are improved and obligations contained
- For loans for P&E, make sure the loan term matches a sensible depreciation period
- Articulate how the client intends to repay (exit strategy) and, where possible, have more than one
On a final note: Semper had the opportunity to meet Kate Carnell, the ombudsman responsible for SMEs, in Canberra to express our work to prevent regulatory overreach in NCCP II. In the backdrop of the royal commission, she has proved rather pragmatic in her approach to encouraging “cultural” changes in banks towards SME lending rather than “regulatory” changes, as she had said “[these changes] might reduce banks’ interest to lend to SMEs”.
Someone, at least, is listening.