Small business finance in Australia : Refinancing mechanism is the answer
Small businesses constitute the backbone of Australian economy. Over 5 million people are employed in 2 million small businesses in Australia which contributes nearly $300 billion to industrial value added every year.
A major concern of the small business is the difficulties in obtaining adequate and affordable finance. The Council of Small Business of Australia (COSBOA) Telstra Back to Business Survey 2010, found that 81 per cent of small businesses were concerned about higher interest rates, 74 per cent were concerned about the cost of finance and 64 per cent were concerned about the availability of finance. Almost half of all respondents identified costs of finance, access to finance or interest rates as their single biggest concern.
While access to finance is crucial the only two sources of funding available to such firms are owners equity and loans from financial institutions.
Unfortunately recent years have witnessed a decline in finance to small businesses. In June 2003, for example, the share of small business in total credit outstanding was 43 per cent, which declined to 29 per cent by June 2009. Similarly, the proportion of small business in total new credit approvals which stood at 31 per cent in June 2003, declined to 23 per cent by June 2007 and now stands at 29 per cent.
Simultaneous with this decline in credit availability, the cost of credit has risen. For example, the spread between interest paid on online savings account and the lending rate charged to small business, jumped from pre-crisis level of 3.80 per cent to 5.55 per cent by January 2009 and stood at 5.70 in March 2010.
Similarly, the difference in weighted average interest rate on credit outstanding between small business and large business - an indicative of risk premium rose. The risk premium which was declining and stood at 1.05 per cent in June 2008, suddenly jumped to 1.95 per cent in June 2009.
The banks also created difficulties for the small businesses in other ways. The NSW Chamber of Commerce, for example, found that even in interest only loans banks insisted on repayment of principle and increased documentary and security requirements were imposed.
Banks, especially the Big Four, dominate the small business lending market and provide over 98 per cent of loans. Interestingly, the major banks were provided tax payer funded guarantee (at lowest guarantee fee in the developed world) to raise funds to ensure unhindered supply of credit to businesses. The above statistics shows banks failed in their duty.
Banks point to increased risk of lending as small businesses are typically information opaque. However, even this argument doesn’t stand. For capital adequacy purposes, banks consider small businesses loans secured by residential property to have the same risk weight (50 per cent) as that of ordinary home loan but when it comes to charging interest on loan the small business becomes suddenly riskier than home loan.
Small businesses are really at the mercy of our major banks. How could we then address the problem of improving access to finance of small businesses?
One way is to introduce more competition in the small business lending market. However, the market is already concentrated with major banks providing a large chunk of the credit. The dominant market power which the Big Four occupy is unassailable.
Yet another suggestion is to provide government guarantee to small businesses to reduce the risk for lenders. Such mechanism exists in other countries such as the US and Canada but have not been found to be cost effective and raise moral hazard issues.
A possible way out is introduction of a refinancing mechanism similar to the Small Industries Development Bank of India (SIDBI). As a Government owned bank, SIDBI is able to raise finance in domestic and international markets at competitive rates which it then on lends to commercial and cooperative banks. These banks seek refinance from SIDBI for their lending to small business.
Such an outfit would free up funds of the lender and increase finance to small business. The lender would continue to bear default risk. The mechanism would also ensure that large businesses would not compete for a share in the credit pie as happens now. By introducing schemes especially for remote regions as well as for women entrepreneurs, the SIDBI has achieved outstanding outcomes.
Establishing a refinancing mechanism for financing small businesses holds much promise to redress the current situation of inadequate and unaffordable access to finance by small businesses.
(Milind Sathye is Professor of Banking and Finance at the University of Canberra and a former central banker)
