In announcing the inquiry into small business lending practices a couple of months ago, the federal government said a Parliamentary Joint Committee had raised serious concerns about banks’ treatment of some of their customers.
So, are banks and SMEs falling out? No longer love at first “site”? It’s difficult. Banks do love small business … but in the way RSLs love pokie players. Banks love small business owners because they are extremely profitable.
Small business is the engine room of the innovation economy and the primary creator of new wealth. Small businesses generate more funds through deposits, term-deposits, employee super and owners’ self-managed super funds than they use in loans. It is the only customer segment that funds itself. But, unlike the big end of town, small businesses are not in a position to negotiate for improved access, better loan pricing, or higher returns on deposits.
Australia has about 1.2 million small businesses that are employers. They represent 70 per cent of private-sector employment, nearly 50 per cent of the value add, and the majority of new-economy growth. There is plenty of demand for finance for SMEs.
Banks and SMEs: an odd love
Banks claim small business customers are a priority, but since the global financial crisis the growth of new funding to the sector has remained stagnant. At the same time, the growth in the cost of capital, cost-to-serve, and cost-of-compliance to lend to SMEs has far outpaced the growth in revenue, causing margins to shrink. With more similar changes on the horizon, the banks may have trouble growing this segment.
The odd love banks have for SMEs goes unrequited. It’s easy to see why. A small business owner can wait weeks for a bank to assess a loan inquiry only to be told they need to mortgage their home or provide other assets as collateral. But many business owners cannot or do not want to provide collateral. As a result, huge numbers of businesses are knocked back when they apply for loans.
Until relatively recently, a bank rejection meant a business had to forsake growth, stretch its own payments or extend terms to the ATO. But more recently, business owners are being referred to a bank’s lending “partner” of choice, which typically charge interest rates of at least 20 per cent, and in some cases can even reach triple digits.
SMEs are finding it more difficult to access credit on the merits of the business alone. The Productivity Commission says businesses are relying on personal savings, credit cards, personal secured bank loans and equity to fund their ventures. SMEs are not feeling the banks’ love. Research from Ian Freeman of Nem Australasia found 71 per cent of SMEs said they had a negative or ambivalent response towards the big four banks. No wonder interest in non-bank finance providers is increasing.
A new solution is born
Luckily a new group of non-bank intermediaries is emerging to provide direct access to the extremely profitable asset classes that have long been solely the domain of banks. The combination of huge volumes of new data, virtually unlimited computing power, and omnipresent networks is enabling innovations like robo-advisers and marketplace lenders to provide lower cost, highly diversified investments for generating reliable, robust and lower capital risk returns.
For small business, the rise of marketplace lenders is providing exactly what they need – access to a network of investors who want better returns, and are willing to lend to them directly.
Business owners and investors are beginning to take notice of the opportunity this represents. In 2014, there was $0 marketplace lending for business conducted in Australia, but according to Morgan Stanley, in 2015 the market reached $25million, and by 2020 it is forecast to grow to $11.4billion, representing 12 per cent of the total addressable market.
It’s clear why this growth is occurring. Marketplace lending addresses the concerns small business has with banks, and the needs for investors for stable fixed-income returns. Businesses can gain access to funding without the need for collateral, being subject to outdated models of risk, or enduring application processes spanning weeks. Sophisticated investors are empowered to take control of their own portfolios, choose the risks they are willing to take, and effectively “be the bank”.
The Turnbull government’s inquiry suggests Australia’s regulators are doing their job to ensure the safety and soundness of the financial system, and that the framework for new competitors supports increased transparency and reduced concentration of risk.
But further opening access to government and industry data could have significant long-term benefits for Australia. It would speed the transition to a more robust digital economy and, along the way, benefit small business, investors and ultimately help our financial institutions adjust to competing in the online age.
Boyd Pederson is founder and CEO of Bigstone, a Cicada Innovations start-up.