‘Blurred lines’: Businesses turn to consumer credit as access to finance worsens

Small business credit conditions have continued to tighten over the last 12 months as entrepreneurs struggle with falling housing prices.

Reserve Bank assistant governor Michele Bullock has said the worsening lending conditions raise the possibility an increasing number of firms will default on their loans, or even fail, particularly in regional areas already ravaged by the ongoing drought.

Speaking at a Toowoomba Chamber of Commerce event on Thursday, Bullock said lending to businesses with less than $50 million in annual turnover has “hardly grown at all” in recent years, despite big business lending increasing by an average 5% year-on-year.

“Small businesses have been facing tighter credit conditions over the past year or so from a level that was already tight,” she said.

While lending conditions have been tight for some time, particularly in the wake of the banking royal commission, Bullock said falling housing prices have made things even more difficult for business owners.

About 50% of small business loans are secured by residential property, which means a reduction in house prices reduces how much small businesses can lend against their houses.

Blurred lines 

But there’s also something else going on.

There is a “blurring in the line between lending to small business and personal credit,” Bullock said.

“The obligations placed on financial institutions for lending to consumers (under responsible lending obligations) are stricter than the requirements for lending to small business, and these have tightened over the past couple of years.

“But lenders are increasingly treating small businesses as household borrowers, imposing the stricter conditions on small business lending.”

Business owners accessing credit as consumers, for example through credit cards, is a longstanding phenomenon but is difficult to quantify. 

Business owners lending as consumers also falls under more comprehensive credit laws than they otherwise would, because small business loans are regulated predominately by an industry code of conduct.

Previous research undertaken by the RBA has also suggested business size is an important factor in lending conditions. Profitability, debt-servicing ratios and credit history are also considered by banks.

However, it can be difficult to determine how individual banks are making decisions about whether to approve or deny a small business loan application. During the banking royal commission, the big four banks opposed an attempt to improve transparency in this area.

David Gandolfo, director of brokerage Quantum Business Finance, says access to finance for small business is an ongoing risk to national prosperity.

“It’s very frustrating,” he tells SmartCompany. 

“The risk is enormous. Small business in aggregate is by far and away the biggest employer in the country.

“If it isn’t able to invest, grow and prosper, it won’t employ or contribute to the national economy.”

Gandolfo agrees the problem has worsened over the last 12 months, saying the banks have been adopting a more cautious approach, even in the wake of the banking royal commission, which cleared up considerable uncertainty.

“The banks have adopted this protective way of doing things … there’s this cookie-cutter approach,” he says.

“If you fit the mould of what they want in a business they will lend you money, but if you want to do something a bit entrepreneurial or untested then they don’t have an answer for you.”

Business funds on the way 

There are efforts underway to improve business lending conditions, amid widespread concern access to finance is holding back SMEs and, by extension, the economy.

Bullock noted yesterday that small business accounts for 70% of employment and 40% of production in the private non-financial sector.

The government is moving ahead with plans to implement a $2 billion Business Securitisation Fund, which will, in theory, improve small business lending conditions by funding non-bank providers, thereby increasing competition in the market.

The policy was announced last year, supported by the small business ombudsman and other advocates, but it has since been criticised by some, who have said the plan does not go far enough and would like to see more money committed.

The small business lending gap is estimated to be in excess of $80 billion, according to Judo Capital and East & Partners research.

This means the securitisation fund is unlikely to fix the problem, Gandolfo says.

“It won’t solve the problem — it will go some way to assisting the market though.”

There’s also the Australian Business Growth Fund, which mirrors a scheme in the UK where banks and superannuation funds come together to support an investment program for high-potential small businesses and startups.

The Australian version of the scheme was announced last year and already has $100 million in the kitty from the government, with hopes it will mature at $1 billion.

However, the fund received a lukewarm reception from the banks and super funds, and it is still not clear which institutions will support the initiative.

Retail sector woes

Bullock also touched on conditions for small firms in the retail sector in her speech, referencing some new data about the way companies in the consumer-facing industry are performing.

Despite the negative commentary streaming from listed discretionary-goods retailers recently, the RBA has found they “appear to be in good financial health overall”, but the same can’t be said for unlisted and smaller retailers.

“Over one-quarter of unlisted retailers are highly indebted, with gearing ratios above 100 per cent,” Bullock said.

“This implies that their debt is larger than their equity and, as a result, they are more vulnerable to asset devaluations or losses.”

The share of loss-making companies among unlisted retailers has also increased in recent years, Bullock said.

Weakness in the sector, alongside broader changes in the way consumers shop, has also had seismic effects on retail property.

Mid-sized shopping centres are being hit most by increasing vacancy, up from 3% to 5%, according to the RBA.

“Landlords have attempted to avoid vacancies by increasing incentives and changing tenancy mixes. And retail valuations have been rising much slower than other commercial property valuations,” Bullock said.

This has, however, resulted in flat rent growth, which stands to provide some semblance of relief to independent retailers.

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