Banks and the myth of 'small' business lending

The indispensable value of small business to the Australian economy is becoming better understood, but at an RBA roundtable last week it was clear bankers need to improve their understanding of small business people.

There’s no doubt that in economic policy settings small business has largely been considered a mini version of big business. This has distorted the way economic policy has been developed and applied.
At a Reserve Bank roundtable last week, for the first time I saw evidence that small business might actually be considered as something distinct from big business. This is important.

The people who work in or run small business make up some 8 million of the 11.5 million Australian workforce. Small business dominates the economy. If economic policies adversely affect small business the economy can be in serious trouble or at least fail to perform to its potential.

It was pleasing to see the Reserve Bank so interested. The RBA had gathered senior representatives from ASIC, APRA, the Productivity Commission, Australian Bureau of Statistics, each of the major banks and some smaller banks, and a discrete collection of small business operators and academics. The governor of the Reserve Bank, Glenn Stevens, was present and engaged throughout, demonstrating the level of importance attached to the event.

In all around 40 people attended in what proved to be a free-wheeling discussion focused mainly on small business finance. Three Reserve Bank powerpoint presentations on small business profiling, facts and data guided the discussion.

There was considerable debate around what constitutes a "small business". In my contribution I made the point that the real definition problem is that the economic idea of 'what is a business' doesn’t match the reality of economic structures.

Conceptually a 'business' is thought of as a managerial system of employees. Businesses function as 'systems' where decisions are made through managerial hierarchies. This might be the reality of medium/big business and the public sector, but this is not the truth of small business.

The distinct nature and uniqueness of small business is that there is no 'system'. It’s individual people who are the business. Business decisions and behaviour are entirely the product of the attributes and failings of individual people. It’s individual people who receive the business rewards or suffer the losses. In big business individual employees are isolated from business losses.

In this respect, it’s more accurate to conceive of 'small business people' rather than small business. They (we) are more closely related to consumers than big business.

If this shift in the concept of small business is accepted, then understanding small business people has a new starting point. Economists (and marketers for that matter) are very used to understanding consumers from the actions and motivations of individuals. Consumers are profiled, dissected and diced into groups, subsets and so on. High levels of behavioural understanding emerge that are invaluable in guiding economic policy.

The trick in understanding small business people is to do the same. In Australia that means detailed surveying of the 2.1 million self-employed people who are and run small businesses. It means discovering the intimate integration of personal and family lives with the business life. These are one and the same.

This focused study does not occur in Australia or globally. We’ve collated some of the better research that’s around but it’s only a start. The lack of understanding is why policy analysis of small business is thin and frequently heavily misconceived. Take one example.

Central to the discussion at the RBA roundtable was small business finance. The six banks present, CBA, NAB, Westpac, ANZ, Rabo and Bendigo were frank and open about how they assess the allocation of loans to small business people. They somewhat exploded as a myth that small businesses have trouble with obtaining finance. The application rejection rate is tiny indeed. Rather the banks have money to lend but can’t find the willing small business borrowers.

What I found curious however was the unquestioned acceptance that small business people pose a greater credit risk than big business or personal lending. I had to question, why is this the case? Why does a business loan to a small business person profile as a higher risk than a personal loan to the same person? On the surface it doesn’t make sense. It’s the same person!

Surely on a public policy front this needs to be understood. Are small business people just comparatively really bad at business, or are there institutional factors at play? I think that institutions play a big factor. But these questions are not being asked or investigated which reflects a misconception of what is a small business (person). The consequence has to be economic policy settings that underperform for small business and the economy itself.

What came out of the Reserve Bank’s open discussion were questions rather than answers. But they were good and fruitful questions. What appeared to me was that this interchange between the Reserve Bank, the commercial banks, institutional regulators and small business, occurring in one room was unique and caused an opening of many eyes. It deserves follow up which I assume would be planned.

Small business (people) needs much more sophisticated understanding than is currently the case.

Ken Phillips is executive director of Independent Contractors Australia and author of Independence and the Death of Employment.