Small businesses the losers in the quest for financial stability

Elizabeth Barry 8 February 2018 NEWS

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APRA regulations may have incentivised some banks against unsecured small business lending.

Australia's prudential rules have put smaller banks in a difficult position when it comes to small business lending, according to the Productivity Commission's draft report into Financial System Competition.

The report, released yesterday, said that some of the interventions of the Australian Prudential Regulation Authority (APRA) have provided "strong incentives" for both lenders and small business borrowers to secure a business loan with a residence as collateral. The draft report also found that, more generally, they created a strong preference for home loan lending over unsecured small business lending.

The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell said that while there should be a focus on stability in the financial sector, policies need to consider the effect of lending to small- to medium-sized enterprises (SMEs).

“Australia’s prudential rules are focused on system stability, which results in limiting small business credit,” Carnell said.

Source: Productivity Commission

Source: Productivity Commission

“It also motivates banks to focus lending against real property security, such as a business owner’s home. This can increase the cost of capital on other lending and to a large degree, limit the ability of SMEs to get funding against other business aspects, such as cash flow."

“Resounding feedback from the SME sector is that access to capital remains a significant barrier despite a healthy pipeline of businesses suitable for investment.”

The issue, according to the Productivity Commission's report, is to do with APRA's interpretation of Basel guidelines on risk weightings. This is what the non-major banks use to determine how much regulatory capital to hold. For all unsecured SME lending, a single risk weight of 100% applies. There is no delineation for the size of borrowing, type of loan or the risk profile of the business. Basel's proposed risk weights for SME lending vary between 75% up to 150%.

Source: Productivity Commission

Source: Productivity Commission

Because of this, Australia's smaller banks are generally required to hold more regulatory capital than the major banks. This means it will cost these smaller banks twice as much to be able to offer unsecured SME loans to customers. Because of the costs, these lenders are incentivised to offer secured SME loans or to have a preference for home loan lending.

Carnell said ensuring small businesses have access to capital is critical to enable their businesses to grow.

“Australia’s 2.2 million SMEs employ two-thirds of Australian workers and contribute $380 billion to the economy."

“If there is no access to capital, then you can’t invest."

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