The final report of the Murray inquiry includes a number of recommendations that will assist Australia’s two million SMEs in gaining access to affordable finance and assist innovative young firms in getting a start.
Over recent years, this sector -- which accounts for almost 70 per cent of industry employment -- has faced a number of structural impediments when accessing credit. SMEs, wich draw around 90 per cent of credit from the major banks, have had to compete against the banks’ preference for much lower risk home loans.
The consequence has been that while larger businesses have been able to diversity their funding sources and access debt through both international and domestic bond markets, SMEs have had few alternatives and have been a faced with a situation akin to the credit rationing we saw before financial deregulation. Only the very lowest risk applicants with strong asset backing are able to access a loan.
While the Murray inquiry has expressed its frustration with the lack of hard data on the state of SME funding, it has obviously been convinced of the need to remove impediments and has put forward recommendations that should go to the heart of the problem. These recommendations will assist SMEs to access credit through wider sharing of information for alternative lenders, providing some recourse for SMEs when faced with stringent non-monetary terms in lending contracts and will also lead to the lowering of interchange fee caps, a significant cost impediment for smaller businesses.
But it is the first of these issues which will likely have the widest ramifications.
Lack of competition and the need to open up SME credit markets to new providers has been an issue right across the developed world. As larger banks have consolidated, centralising credit approval and becoming more remote from the SME clients, it has become more difficult for smaller firms to gain credit. This trend has accelerated since the GFC and steps have been taken in a number of countries to encourage more competition in the SME market.
In order to reduce information asymmetry and provide access to information on SMEs, previously tightly held within the banking system, the UK government, for example, has legislation before the parliament to mandate sharing of SME borrower information between banks and SME lenders. The Small Business, Enterprise and Employment Bill 2014-15 is currently in its second reading, and promises to open this market up to more competition.
In the US and the UK, market based solutions are also evident in the rapid growth of online credit providers and peer-to peer models. Firms in this space include the Lending Club, Kabbage and OnDeck. By utilising technology and algorithms to assess and largely automate the loan approval process, online lenders are providing competition to the large banks which have traditionally dominated SME lending. Online lenders currently have nowhere near the same amount of capital to engage in lending as the large US banks, but recently OnDeck was able to successfully securitize a portion of its loan portfolio, which was sold on to mutual funds and insurers.
In Australia, online lending is still in its infancy, but new entrants don’t need to have a large share of the market to have a major impact on competition, as we saw in the mortgage market in the late 1990s.
At that time, despite having only a small market share, new entrants using RMBS were able to have such an impact on the market that the margin on home lending dropped from 4 per cent to 1.5 per cent over the period from 1996 to 2000.
The recommendation to expand data sharing on SMEs, under the new voluntary comprehensive credit reporting regime, is sure to accelerate this trend and encourage innovation and competition in the SME credit market.
Professor Deborah Ralston is executive director of the Australian Centre for Financial Studies