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Banking on trust

Banking on trust

Many small businesses are feeling the pinch, and part of the pinch they’re feeling is finance. Common complaints are that banks won’t touch new businesses and that they are fixated on lending against bricks and mortar, rather than looking at cash flow.

by David Walker | Jun 1, 2013

Typical is an accountant Public Accountant spoke to recently who cited a client’s problems: his new business had paid cash for a prime mover and had a contract in place, but his bank told him that he needed to be in business for two years before they would finance further expansion.

Banks, for their part, insist they haven’t changed their lending criteria, although some have reduced loan-to-valuation ratios on home mortgages.

What’s the real problem here? Is it that banks are unwilling to finance small businesses? Or have they just returned to pre-boom sanity? Or is something else going on?

Some facts are clear. While bank interest rates fell in 2008, interest rate ‘spreads’ – the difference between the official cash rate and actual lending rates – jumped. And small business spreads rose furthest. The gap between

large business rates and small business rates is now almost 1 per cent higher than it was in 2007 and shows no sign of falling. Indeed, the RBA reported in a March 2013 research paper1 that spreads on small business variable-rate lending had risen in the first half of 2012. That was partly because such loans were usually secured by housing and thus were priced like home loans.

The increase in the relative price of small business lending is, in a sense, quite understandable once you accept that banks are now less trusting of risk. As another RBA research paper concluded last year2, small businesses are inherently riskier than large ones: their revenues are viewed as more volatile, and they are less likely to have diverse supplies, products and customers. They are more than twice as likely to default as housing loan customers, and lenders lose more when they do.

That is why banks have always charged them more for loans. After the 2008 shock, the price of riskier lending went up.

Cautious approach

But have banks shut the doors to small business? If that were true, we’d expect to see small business loans making up a smaller and smaller share of total bank business lending over time. In fact, lending to small businesses has not fallen as sharply since the GFC as lending to large businesses3. There is simply not enough evidence that banks are systematically avoiding small business loans.

Even the small business lobby group COSBOA (Council of Small Business Australia) admits that it’s hard to sort out the big truths from the heady mix of anecdotes and statistics now swirling around. “What we keep hearing is that it’s hard to get money from the banks,” COSBOA executive director Peter Strong told media a few months ago, “but we need a lot more information to take into policy discussions.”

COSBOA is now undertaking a joint research program with the bankers’ lobby group, the Australian Bankers’ Association.

The available information is consistent with the picture in Public Accountant’s following story: banks will lend, but they worry more about their risks. They want lower gearing, better interest cover, a longer track record and a more detailed presentation of forward plans.

This approach obviously provides less lending than the old approach. As RBA assistant governor (financial markets) Guy Debelle noted recently4, trust was easily given in the years before the crisis. Complacency set in, and many loans were priced too cheap.

Those days have gone. And they may not return any time soon. RBA assistant governor (financial system) Malcolm Edey has talked5 of a “new normal”, where rates stay low but banks stay cautious.

Since its earliest days, accounting has been about creating trust. When lenders need to create more trust among borrowers, accountants have an opportunity.