“Holding back the economy”: What’s causing the SME credit drought?

IT services entrepreneur James Eling isn’t one for sitting on his hands in the face of uncertain times, and like many small business owners across the country, he’s looking to invest for the future.

The owner of Extreme Networks, he has been building a co-working space out of his office in an attempt to diversify his company’s revenue streams and utilise unused space. But when he went to the banks for a loan, they knocked him back.

“They said no, this guy is self-employed,” Eling tells SmartCompany.

Eling has been running businesses for more than 20 years and managed to consistently grow his company through the global financial crisis (GFC) in 2008-9, but a $30,000 loan to help him get his co-working space off the ground was a step too far for Australia’s major lenders.

Instead, he’s resorted to funding the expansion from his company’s cashflow, deciding his business will be in a better position to deal with any potential downturn in the economy if he invests now.

“For every business in our position, there will be 20 who will decide not to expand because they can’t fund it out of cashflow,” Eling says.

“It’s really holding back the economy.”

Access to finance has been a prevalent issue for small businesses for some time, but new concern has emerged over the last week that the problem is getting worse in the face of renewed anxiety about Australia’s economic health.

Are businesses being knocked back?

Among those sounding the klaxon are non-bank lenders, who are pushing data claiming the big four banks have tightened the screws on capital over the last 12 months.

Lender Judo’s latest small business report found fewer than one-in-two SMEs sought new finance in 2018/19, with an average value of $1.1 million.

It found 74.8% of businesses pursuing an average of $800,000 in finance were successful, while 25.2% of SMEs reported failed applications for loans averaging $2 million.

Matching platform ebroker.com.au released a survey of 10,000 firms earlier this week which found access to finance is thwarting growth, particularly for entrepreneurs without property to leverage.

In particular, ebroker found small businesses without property to leverage against are at a distinct disadvantage, despite accounting for 60% of loan enquiries.

Non-bank lenders have a financial incentive to push the view that their big bank competitors are keeping capital behind lock and key, but they aren’t the only ones ringing alarm bells.

In a report released earlier this month by the Council of Financial Regulators (CFR) — with members including the Reserve Bank of Australia (RBA), the Australian Securities and Investments Commission, the Australian Prudential Regulation Authority (APRA) and Treasury — said tighter lending standards for small businesses had been a “significant focus” in recent meetings.

“Lending to small businesses has hardly grown over the past year, compared with a 5 per cent increase in lending to large businesses,” the CFR report said.

“Harder to fund operations”

The council offered two reasons for the lack of small business lending growth: weaker demand for credit, which itself is a warning sign for a softer economy, and tighter lending standards, with banks treating the division between personal and small business finances with “more caution”.

“Small businesses also report that tighter credit conditions have made it harder to fund their operations or refinance debt.”

There’s a considerable amount of anxiety behind the notion that small businesses are finding it more difficult to access finance, particularly because private capital drying up has been a precursor to economic downturn in the past.

Back in May, Treasurer Josh Frydenberg warned the banks about their “social responsibility to lend” in the wake of a meeting with APRA about easing borrowing restrictions.

The government is also working on implementing $1.1 billion in new programs designed to improve access to finance for Aussie SMEs, including the Australian Business Securitisation Fund, which will essentially subsidise small lenders, and the Australian Business Growth Fund, which would create a new capital avenue for a very small number of high-potential SMEs.

In response to the Reserve Bank moving the official cash rate to an all-time low of 0.75% earlier this month, small business ombudsman Kate Carnell said SMEs need the support of financial institutions.

Responding to comments by RBA governor Philip Lowe that the lending standards pendulum may have swung too far, Carnell said last week access to finance has emerged as the biggest barrier to small business growth.

“The overwhelming feedback to my office from the small business community is that a lack of access to funding is their biggest barrier to growth,” Carnell said.

“It’s time we all sit up and listen to the RBA governor. If our financial institutions change the way they do business with SMEs, it might just give small businesses the confidence they need to grow, which would be of significant benefit to the Australian economy.”

Are businesses getting it wrong?

Major bank lobbyist the Australian Banking Association (ABA) has disputed the idea its members are restricting capital flow to small firms, saying in September that over 90% of small business loans are being approved.

ABA chief executive Anna Bligh has said the volume of applications is in decline, citing commissioned research.

“Small business loan applications have declined by a third (33%) since the 2014 calendar year,” Bligh said in an August press release. 

“Encouragingly, there has been a lift in the June quarter. It’s early days, but we hope that it will continue.”

While the application decline could be explained by shifting market share to smaller non-bank lenders, the ABA has floated the view that some businesses may be finding the lending process too complex.

The lobby group has launched a website in collaboration with the Council of Small Businesses Australia (COSBOA) that aims to provide tips to business owners about how to structure their applications.

A recurring gripe among small business advocates outlined repeatedly during the banking royal commission was that the loan application and approval process can be difficult to navigate, particularly when it comes to the way banks make decisions about approving loans.

NAB, Commonwealth Bank and ANZ all argued that flexibility in the SME loan approval process should be maintained in their response to the royal commission’s interim report, amid concern from the small business ombudsman that “get out of jail clauses” in industry regulation reduce confidence and certainty for business owners.

Shoddy applications

Others argue business owners are fudging the loan application process. Leo Tyndall, founder of non-bank lender Marketlend, says his company regularly gets overly ambitious or just plain shoddy applications.

Tyndall argues more work needs to be done to improve guidance for SMEs to ensure their loan applications are fit for purpose.

“I don’t think the banks have changed from their usual position … they only do business loans if there’s property collateral,” Tyndall tells SmartCompany.

What’s changed, according to Tyndall, is the major banks are increasingly assessing risk more closely, scrutinising existing business debts in particular.

“Debt servicing ratios haven’t been as important previously in the SME space,” Tyndall says.

This means that businesses who may have sought short-term finance in the past may be finding it more difficult to secure longer-term loans.

An equity gap?

Tyndall advises businesses to submit loan applications that detail three-year projections for profitability that include the finance they’re applying for.

But Tyndall also says business owners should look towards alternative options, such as convertible debt plans or even equity raises.

Tyndall notes Australia’s equity finance space is not as sophisticated as those in the United States and the United Kingdom, arguing the amount of venture capital flowing into Australia pales in comparison to other markets.

“The gap is not in finance, it’s more about investment in small business. It’s an equity investment gap,” Tyndall argues.

Venture capital investment in Australia has been increasing in recent years, reaching a record high of $1.25 billion in the fourth quarter of last year, according to KPMG figures.

However, while total investments increased in 2018, the number of companies receiving venture capital decreased, with just 114 deals inked.