SME lending transformation

11 October 2021

Every year, one in six small businesses – about 400,000 businesses - apply for debt finance.

Many of them need credit to juggle cash flows. Some want to fund growth. But, for one in four, their survival is at stake. Especially for new businesses turning over less than $500,000 a year, obtaining finance is a matter of life or death.

Productivity Commission research shows a lending market being transformed, as demand for unsecured credit prompts a raft of new providers and products. Innovative lenders with new business models are using technology and data to identify creditworthy applicants.

Yet old debates persist about whether funds are flowing smoothly to small business – in particular, whether banks are constricting credit.

Banks are usually the first port of call for small business owners seeking finance. Most applications are successful.   Small businesses with assets, especially property, can readily obtain money at competitive rates.  The small business lending market is large – more than $420 billion – and dominated by the banks, which hold up to 90 per cent of small business debt.

Yet surveys report that some small business operators believe they are struggling because of a lack of access to funds.  The OECD agrees and warns that access is deteriorating.  Many reasons are offered.  Banks have become more risk-averse, preferring mortgages to business loans.  New prudential regulations have made business lending more costly.  Cost cutting has killed relationship banking; local bank managers no longer have the skills or the authority to assess and write small business loans.  Even when finance is available, bank processes can be slow and painfully bureaucratic.

The challenges are most acute for small businesses that lack property assets.  While about half of small business loans are secured by residential mortgages, not all small business owners have that option.  Many businesses, especially in the services sector, do not hold property assets.

There are signs of change. While consumer credit is tightly regulated, business to business lending is lightly regulated and there are few barriers to entry.  Non-bank lending is growing quickly, from a low base. The market has a new vocabulary – neo-banks, fintechs, private credit.

With the consent of applicants, lenders access real-time data through online bank and accounting systems.  As open banking is phased-in, prospective borrowers can readily share their data with lenders.  Better access to data means more accurate pricing of risk, facilitating more lenders and better priced products.

As data flows improve, the concept of security is changing.  Property remains the gold standard but less tangible assets can now be monetised.  Once a niche product, invoice finance is much more widely available.  A small business can borrow against the security of its outstanding invoices, underwriting a line of credit or a term-limited loan. The same business could on-sell its book, at discounted rates, to a lender.  Borrowers benefit from receiving early revenue to smooth cash flow.

The benefits for small business are real.  Many small businesses can obtain credit quickly, with or without traditional securities.  Some businesses may qualify for credit for the first time.

The growth of these new lending options has been rapid but is still largely on the margins of the market. The potential for rapid growth is obvious but it will turn on three broad shifts.

Non-bank lenders need access to more funds. As these lenders mature, more funding options are available including listing on stock exchanges and securitisation of the loans. Better reporting and more standardised products could help attract more investment. The federal government’s $2 billion Australian Business Securitisation Fund, followed by the $15 billion Structured Finance Support Fund, should create a deeper pool of capital for small business lending and attract sustained private investment.

Lenders need to raise awareness of their products amongst small business owners.  The raft of new products is confusing.  Small business owners are time-poor and need support to understand their options.  Brokers play a valuable role.

Australia is catching up with other countries in the range of financial products available to small businesses.  Technology, competition and innovation are driving a more flexible market for the 2.4 million small businesses in Australia.  As these trends accelerate, the prospects for small business finance look promising.