Opinion piece in the SYdney Morning Herald and the Age Melbourne published simultaneously
Banks need reining in, but an act is not the way
Milind Sathye
October 22, 2010 - 3:00AM
Advertisement Joe Hockey has suggested the use of punitive measures by Parliament against banks that do not keep their interest rates in line with the Reserve Bank cash rate. But can Parliament take punitive measures, and, if so, in what circumstances?
Parliament has already conferred powers on the government to control interest rates, under section 50 of the Banking Act 1959. The section also provides for imposition of a financial penalty on banks that defy the directive.
These powers are, however, for use in exceptional circumstances. Even in the global financial crisis, countries such as the US and Britain have not used such powers. It would be against the grain of a market economy to do so.
How, then, do we rein in recalcitrant banks?
Recalcitrance arises out of the market power banks wield. For example, in June banking assets in Australia were 215 per cent of GDP. The proportion was 115 per cent, 87 per cent and 84 per cent for Britain, Canada and the US respectively.
Government policies during the GFC helped banks consolidate market power.
The Westpac-St George and CBA-Bankwest mergers; a bank wholesale funding guarantee at a fee that was the lowest in the developed world; a deposit guarantee of up to $1 million, which resulted in migration of funds from other institutions to banks; and favourable tax treatment have made Australia's banking system one of the most concentrated and profitable banking systems in the world.
But have ordinary Australians or small businesses been helped?
Small business's share in the pie of bank credit declined from 43 per cent (June 2003) to 30 per cent (June 2010). Banks favoured the big end of town while small businesses reeled under pressure of lower credit availability and higher costs. A small business variable overdraft rate that was 9.7 per cent (pre-crisis) now stands at 10.3 per cent while large businesses continue to pay lower on their credit outstanding (7.05 per cent pre-crisis and 6.45 per cent now).
A taxpayer-funded guarantee was provided to banks to enable unhindered credit supply to Australians. Obviously banks ignored social responsibility.
Australian families pay interest rates higher than pre-crisis levels on all loan types except housing loans. However, even for housing loans the mark-up over the Reserve Bank cash rate, which for decades was 1.8 per cent, has jumped to 2.9 per cent, raising the standard variable mortgage rate to as high as 7.4 per cent in September.
Interestingly, the return on deposits, which provide half of bank funding, has not risen. The average rate on all term deposits (currently 4.4 per cent) is still below the pre-crisis level. Banks touted the high-funding-cost argument to raise lending rates, an argument this author debunked with evidence through opinion articles earlier this year. The Reserve Bank, too, has debunked it in its latest monetary policy.
If ordinary Australians and small businesses have not benefited from banks, who has benefited? The big end of town continues to get loans on favourable terms.
Second, bank officials fill their pockets. A Productivity Commission study found that while remuneration for chief executives in Australia averaged that in Europe (but was less than in the US), such remuneration in Australia's finance sector was closer to the US rate.
Bank shareholders are leading the world in shareholder returns. The average five-year total return in Australia was 9.2 per cent, ahead even of Canada, which stood at 8.9 per cent.
Australian families and small businesses have to submit meekly to the growing arrogance of our banks. The banks have become so powerful they virtually decide government policy. How else could major banks get wholesale funding guarantees at a fee that was the lowest in the developed world?
The only thing that may possibly rein in our banking behemoths is the threat to break them up.
US President Barack Obama's banking reforms have given such powers to the US government and the Bank of England governor recently advocated a similar course.
Banks need to be subjected to community oversight, perhaps through appointing a community representative to the board. Joe Hockey is right: we need to rein in the banks, but it has to be through more competition and community oversight and not by using powers under the Banking Act.
Milind Sathye is professor of banking and finance at the University of Canberra and previously worked for the Central Bank of India.
This story was found at: http://www.smh.com.au/business/banks-need-reining-in-but-an-act-is-not-the-way-20101021-16w4l.html
Sunday, October 31, 2010
bank guarantee
Rudd should dip his cap to undo damage Milind Sathye From: The Australian October 27, 2008
MUCH water has flowed under the bridge since I questioned on this page on October 15 the Rudd Government's decision to introduce a blanket financial guarantee.
The Opposition has walked away from its initial support and instead turned up the heat on the Government. A senate estimates committee tried to investigate what advice the Government received before the decision was made. Most importantly, unintended consequences of the decision - the distortion of financial flows in the money market - have come to the fore.
Why have we arrived at this situation less than a fortnight after the Government announced its decision, which initially was hailed by almost everyone? Could the run on non-bank financial institutions have been avoided? Did policy makers carefully scan what measures other countries took and why? Was there really a need to take an extreme measure such as a blanket financial guarantee in a hurry? Was a three-year guarantee ab initio necessary? And what do we do to get out of this mess?
Ireland was the first country to announce a financial guarantee, on September 29, as the global credit crisis deepened. However, it initiated the measure in stages. On September 20 it merely raised the ceiling on deposit guarantees from E20,000 ($40,664) to E100,000 and applied it selectively, only to individual deposits and to Irish credit institutions.
Nine days later the guarantee was extended to "all deposits" - retail, commercial, institutional and interbank - of selected banks. Significantly, the Government specifically announced it acted on the advice of its central bank.
It is important to realise that the Government took these decisions because Ireland was facing a property market meltdown, a credit crunch, its first recession in 25 years and the effects of the global credit crisis. Yet even in such an extreme situation the country approached the problem in stages.
Australian actions were in stark contrast to those of the Irish Government. The Rudd Government made an unprecedented change from no guarantee whatsoever (the $20,000 deposit guarantee was not approved by parliament) to a blanket guarantee.
And while the Irish guarantee was applicable to select financial institutions (domestic banks and other institutions), the Australian guarantee was applicable to all banks - whether domestic or foreign - credit unions and building societies.
Implementation in stages would have helped the Australian Government know the impact of the measures and then take further corrective action. This could have avoided the present distortion in the market.
Crucially, the Irish decision was made after advice from the central bank; in Australia we still don't know what the RBA advised.
Interestingly, the US and Britain, the worst-affected countries, didn't introduce blanket deposit guarantees.
In Britain the deposit guarantee was raised from pound stg. 37,000 ($94,631) to pound stg. 50,000. Again, Britain was severely affected by the crisis, unlike Australia, and yet still decided to move in stages. Of course, it introduced the emergency measure of recapitalisation of banks simultaneously. But these were extraordinary circumstances in the British financial system, not even a semblance of which was experienced in Australia, and still the British Government did not introduce a blanket guarantee.
The case of the US, the country most hit by the crisis, was no different. The Fed raised the deposit guarantee from $US100,000 ($161,342) to $US250,000 in the midst of the crisis but yet again no blanket guarantee was proposed.
Blanket financial guarantees are an emergency measure. Turkey, for example, underwent in upheaval in its financial system in the mid-1990s. Overnight interest rates had peaked at 1000 per cent, resulting in panic in the financial system. Banks faced a severe liquidity crunch due to substantial deposit withdrawals. The International Monetary Fund was called in, three banks were taken over and a full guarantee to all savings deposits was introduced until May 2000.
That is the kind of situation that calls for emergency measures such as blanket guarantee or bank nationalisation. Was Australia facing such a situation?
It seems that with the stock market tumble on October 11, panic buttons got pushed. Granted the markets needed a boost, but the Government could have moved in stages rather than taking hasty action with resultant adverse effects.
The Government's announcement on Friday of a free guarantee for deposits below $1 million and a paid guarantee for those above $1 million still doesn't address the distortion.
What it does is create four market segments: those below $1 million (99.5 per cent of the market) with either free cover or no cover, and those above $1 million with either paid cover or no cover.
Financial flows will continue in the sub-$1 million segment from the no cover zone to the free cover zone, and even in the above-$1 million segment from the no cover zone to the paid cover zone if there is an advantage after factoring in the cost of cover.
Also, if one has a deposit of $1million, one needs withdraw only $1 to get free cover, and if you have $10 million you just need to spread it over 10 institutions evenly to avoid paid cover. Such games will now begin in the market place.
To get out of this mess of its own making, the Government should unwind its blanket guarantee and instead cap it at $60,000. If required, it could be progressively scaled up. This would normalise financial flows in the market.
The unlimited deposit guarantee also puts the commercial paper market at a severe disadvantage in relation to the deposit market. As commercial papers are generally in denominations of $100,000 or more, a cap of $60,000 would permit normal functioning of the CP market.
Last, Australians need to know exactly what advice was given by the RBA. The Government says its actions have been supported by the RBA, but there is a difference between a recommendation and support. A recommendation is given prior to the decision while support is offered afterwards.
What we need to know is whether the RBA recommended a blanket deposit guarantee as the central bank in Ireland did. Given the problems in the financial flows that surfaced following the decision to offer a blanket guarantee, it seems unlikely the RBA would have recommended it.
If it had, it would mean that it was unable to foresee the problems that would arise in the market. That would suggest incompetence on the part of the RBA. This is highly unlikely and leads us to the conclusion that probably a decision was taken by the Government and the RBA was then asked to support it. If this is what has happened, then it is the Government that is undermining our economic institutions.
Milind Sathye is a professor of banking and finance at the University of Canberra and a former central banker in India.
MUCH water has flowed under the bridge since I questioned on this page on October 15 the Rudd Government's decision to introduce a blanket financial guarantee.
The Opposition has walked away from its initial support and instead turned up the heat on the Government. A senate estimates committee tried to investigate what advice the Government received before the decision was made. Most importantly, unintended consequences of the decision - the distortion of financial flows in the money market - have come to the fore.
Why have we arrived at this situation less than a fortnight after the Government announced its decision, which initially was hailed by almost everyone? Could the run on non-bank financial institutions have been avoided? Did policy makers carefully scan what measures other countries took and why? Was there really a need to take an extreme measure such as a blanket financial guarantee in a hurry? Was a three-year guarantee ab initio necessary? And what do we do to get out of this mess?
Ireland was the first country to announce a financial guarantee, on September 29, as the global credit crisis deepened. However, it initiated the measure in stages. On September 20 it merely raised the ceiling on deposit guarantees from E20,000 ($40,664) to E100,000 and applied it selectively, only to individual deposits and to Irish credit institutions.
Nine days later the guarantee was extended to "all deposits" - retail, commercial, institutional and interbank - of selected banks. Significantly, the Government specifically announced it acted on the advice of its central bank.
It is important to realise that the Government took these decisions because Ireland was facing a property market meltdown, a credit crunch, its first recession in 25 years and the effects of the global credit crisis. Yet even in such an extreme situation the country approached the problem in stages.
Australian actions were in stark contrast to those of the Irish Government. The Rudd Government made an unprecedented change from no guarantee whatsoever (the $20,000 deposit guarantee was not approved by parliament) to a blanket guarantee.
And while the Irish guarantee was applicable to select financial institutions (domestic banks and other institutions), the Australian guarantee was applicable to all banks - whether domestic or foreign - credit unions and building societies.
Implementation in stages would have helped the Australian Government know the impact of the measures and then take further corrective action. This could have avoided the present distortion in the market.
Crucially, the Irish decision was made after advice from the central bank; in Australia we still don't know what the RBA advised.
Interestingly, the US and Britain, the worst-affected countries, didn't introduce blanket deposit guarantees.
In Britain the deposit guarantee was raised from pound stg. 37,000 ($94,631) to pound stg. 50,000. Again, Britain was severely affected by the crisis, unlike Australia, and yet still decided to move in stages. Of course, it introduced the emergency measure of recapitalisation of banks simultaneously. But these were extraordinary circumstances in the British financial system, not even a semblance of which was experienced in Australia, and still the British Government did not introduce a blanket guarantee.
The case of the US, the country most hit by the crisis, was no different. The Fed raised the deposit guarantee from $US100,000 ($161,342) to $US250,000 in the midst of the crisis but yet again no blanket guarantee was proposed.
Blanket financial guarantees are an emergency measure. Turkey, for example, underwent in upheaval in its financial system in the mid-1990s. Overnight interest rates had peaked at 1000 per cent, resulting in panic in the financial system. Banks faced a severe liquidity crunch due to substantial deposit withdrawals. The International Monetary Fund was called in, three banks were taken over and a full guarantee to all savings deposits was introduced until May 2000.
That is the kind of situation that calls for emergency measures such as blanket guarantee or bank nationalisation. Was Australia facing such a situation?
It seems that with the stock market tumble on October 11, panic buttons got pushed. Granted the markets needed a boost, but the Government could have moved in stages rather than taking hasty action with resultant adverse effects.
The Government's announcement on Friday of a free guarantee for deposits below $1 million and a paid guarantee for those above $1 million still doesn't address the distortion.
What it does is create four market segments: those below $1 million (99.5 per cent of the market) with either free cover or no cover, and those above $1 million with either paid cover or no cover.
Financial flows will continue in the sub-$1 million segment from the no cover zone to the free cover zone, and even in the above-$1 million segment from the no cover zone to the paid cover zone if there is an advantage after factoring in the cost of cover.
Also, if one has a deposit of $1million, one needs withdraw only $1 to get free cover, and if you have $10 million you just need to spread it over 10 institutions evenly to avoid paid cover. Such games will now begin in the market place.
To get out of this mess of its own making, the Government should unwind its blanket guarantee and instead cap it at $60,000. If required, it could be progressively scaled up. This would normalise financial flows in the market.
The unlimited deposit guarantee also puts the commercial paper market at a severe disadvantage in relation to the deposit market. As commercial papers are generally in denominations of $100,000 or more, a cap of $60,000 would permit normal functioning of the CP market.
Last, Australians need to know exactly what advice was given by the RBA. The Government says its actions have been supported by the RBA, but there is a difference between a recommendation and support. A recommendation is given prior to the decision while support is offered afterwards.
What we need to know is whether the RBA recommended a blanket deposit guarantee as the central bank in Ireland did. Given the problems in the financial flows that surfaced following the decision to offer a blanket guarantee, it seems unlikely the RBA would have recommended it.
If it had, it would mean that it was unable to foresee the problems that would arise in the market. That would suggest incompetence on the part of the RBA. This is highly unlikely and leads us to the conclusion that probably a decision was taken by the Government and the RBA was then asked to support it. If this is what has happened, then it is the Government that is undermining our economic institutions.
Milind Sathye is a professor of banking and finance at the University of Canberra and a former central banker in India.
Bank funding costs
Opinion piece in the Age Melbourne 06 April 2010
Let's see the flip side of bank funding costs
Milind Sathye
April 6, 2010 - 3:00AM
Advertisement THE chairman of Westpac in a recent interview signalled that lending rates would continue to rise in the next five years - no matter what happens to the official cash rate. He said there was a permanent shift in the driver of interest rates on loans and deposits to international wholesale money markets.
Nothing could be further from the truth.
International wholesale funding constitutes only about 26 per cent of total bank funding. The cost of this funding has in fact declined below pre-crisis levels.
Analysts measure banks' reluctance to lend by comparing the London interbank offer rate (LIBOR), which is based on the rate banks charge other banks to borrow money without security, to the overnight indexed swap (OIS) rate, which is derived from the central-bank-defined overnight rate.
Over the five years preceding the financial crisis, the LIBOR-OIS spread averaged 0.11 percentage points. Last week it stood at 0.08 percentage points, that is, below pre-crisis levels. The story of the cost of other sources of funding is no different. Deposits constitute more than 52 per cent of bank funding, and the cost has declined, except for special-rate deposits (see table).
Another test to debunk the rising deposit cost argument is the actual interest expenses on deposits. Interest paid by banks on deposits declined from $74 billion (June 2008) to $70 billion (June 2009), according to the latest data from the Australian Prudential Regulation Authority.
Interestingly, the outstanding bank deposits rose from $1.4 trillion (June 2008) to $1.6 trillion (June 2009), a rise of $203 billion. Consequently, the cost of deposits to average deposits fell from 5.75 per cent to 4.59 per cent over the period. Importantly, transaction accounts that constitute 9 per cent are free of that cost. Yet banks continue to harp that their deposit costs after the crisis are higher than before the crisis, and to justify higher lending rates on this basis.
Domestic debt constitutes the remaining 22 per cent of bank funding for which another spread, comparing the bank bill swap rate to the OIS, is often used as a gauge. That spread was about 0.1 of a percentage point before the crisis, blew out to about 1.5 percentage points during the crisis and is now down to 0.27 of a percentage point. For long-term domestic borrowing, the pre-crisis spread was 0.15 of a percentage point, which rose to 2.61 percentage points but is now down to 0.86 of a percentage point.
But the best indicator of overall cost of funding is what banks actually pay for wholesale borrowing. The overall cost of funding measured by the proportion of total interest expenses to total liabilities fell from 5.29 per cent to 4.30 per cent, using statistics published by APRA. And the Reserve Bank study on bank funding costs, published in its June 2009 bulletin, has a graph of major banks' average funding costs that shows a clear decline in overall funding cost.
Interestingly, banks tell only one side of the story - the funding cost story - and never the combined story of cost, revenue and profits at one place. For example, the Australian Bankers Association fact sheet in February made a case that funding costs are rising. Curiously, the association forgot the cost of borrowing from international markets altogether; there was no mention of this cost.
But there is one set of numbers that has certainly gone up - that of bank profits. The operating profit of banks rose by $6 billion in the year ending June 2009, compared with the year ending June 2008, and it was not because banks became more efficient. The ratio of operating expenses to total assets (an indicator of efficiency) of the majors remained unchanged at 1.4 per cent in the two years, according to APRA.
The Treasury secretary recently admitted the major banks consolidated their market power due to the crisis. The government policy in the crisis actually helped the big banks consolidate market power.
The fee structure for the bank guarantee put in place by the government helped banks make record profits at the cost of the taxpayer. It also discriminated against community institutions such as credit unions. The fee was risk-based (0.7 of a percentage point for the majors and up to 1.5 percentage points for others) instead of market-based as in Denmark or debt maturity-based as in the US or Britain.
Banks raised about $106 billion by June 2009. As the KPMG Financial Institutions Performance Survey 2009 shows, in the six months ending June 2009, banks' spread (the difference between average borrowing cost and average lending rates) increased by 0.21 of a percentage point. Accordingly, over a three-year period, the profit made by banks works out to $1.34 billion out of the wholesale funding guarantee alone - leaving aside the deposit guarantee.
Putting it another way, $1.34 billion is a taxpayer-funded subsidy for banks - mainly the majors, the main issuers of the debt.
The government now wants small financial institutions to pose competition to major banks after having done everything they could to benefit the majors. The major banks need to be made accountable. The solution lies in making the information on bank funding costs, lending rates, margins as well as fees and the international comparisons publicly available.
Milind Sathye is a professor of banking and finance at the University of Canberra and a deputy general manager of the Reserve Bank of India.
This story was found at: http://www.theage.com.au/business/lets-see-the-flip-side-of-bank-funding-costs-20100405-rn5q.html
Let's see the flip side of bank funding costs
Milind Sathye
April 6, 2010 - 3:00AM
Advertisement THE chairman of Westpac in a recent interview signalled that lending rates would continue to rise in the next five years - no matter what happens to the official cash rate. He said there was a permanent shift in the driver of interest rates on loans and deposits to international wholesale money markets.
Nothing could be further from the truth.
International wholesale funding constitutes only about 26 per cent of total bank funding. The cost of this funding has in fact declined below pre-crisis levels.
Analysts measure banks' reluctance to lend by comparing the London interbank offer rate (LIBOR), which is based on the rate banks charge other banks to borrow money without security, to the overnight indexed swap (OIS) rate, which is derived from the central-bank-defined overnight rate.
Over the five years preceding the financial crisis, the LIBOR-OIS spread averaged 0.11 percentage points. Last week it stood at 0.08 percentage points, that is, below pre-crisis levels. The story of the cost of other sources of funding is no different. Deposits constitute more than 52 per cent of bank funding, and the cost has declined, except for special-rate deposits (see table).
Another test to debunk the rising deposit cost argument is the actual interest expenses on deposits. Interest paid by banks on deposits declined from $74 billion (June 2008) to $70 billion (June 2009), according to the latest data from the Australian Prudential Regulation Authority.
Interestingly, the outstanding bank deposits rose from $1.4 trillion (June 2008) to $1.6 trillion (June 2009), a rise of $203 billion. Consequently, the cost of deposits to average deposits fell from 5.75 per cent to 4.59 per cent over the period. Importantly, transaction accounts that constitute 9 per cent are free of that cost. Yet banks continue to harp that their deposit costs after the crisis are higher than before the crisis, and to justify higher lending rates on this basis.
Domestic debt constitutes the remaining 22 per cent of bank funding for which another spread, comparing the bank bill swap rate to the OIS, is often used as a gauge. That spread was about 0.1 of a percentage point before the crisis, blew out to about 1.5 percentage points during the crisis and is now down to 0.27 of a percentage point. For long-term domestic borrowing, the pre-crisis spread was 0.15 of a percentage point, which rose to 2.61 percentage points but is now down to 0.86 of a percentage point.
But the best indicator of overall cost of funding is what banks actually pay for wholesale borrowing. The overall cost of funding measured by the proportion of total interest expenses to total liabilities fell from 5.29 per cent to 4.30 per cent, using statistics published by APRA. And the Reserve Bank study on bank funding costs, published in its June 2009 bulletin, has a graph of major banks' average funding costs that shows a clear decline in overall funding cost.
Interestingly, banks tell only one side of the story - the funding cost story - and never the combined story of cost, revenue and profits at one place. For example, the Australian Bankers Association fact sheet in February made a case that funding costs are rising. Curiously, the association forgot the cost of borrowing from international markets altogether; there was no mention of this cost.
But there is one set of numbers that has certainly gone up - that of bank profits. The operating profit of banks rose by $6 billion in the year ending June 2009, compared with the year ending June 2008, and it was not because banks became more efficient. The ratio of operating expenses to total assets (an indicator of efficiency) of the majors remained unchanged at 1.4 per cent in the two years, according to APRA.
The Treasury secretary recently admitted the major banks consolidated their market power due to the crisis. The government policy in the crisis actually helped the big banks consolidate market power.
The fee structure for the bank guarantee put in place by the government helped banks make record profits at the cost of the taxpayer. It also discriminated against community institutions such as credit unions. The fee was risk-based (0.7 of a percentage point for the majors and up to 1.5 percentage points for others) instead of market-based as in Denmark or debt maturity-based as in the US or Britain.
Banks raised about $106 billion by June 2009. As the KPMG Financial Institutions Performance Survey 2009 shows, in the six months ending June 2009, banks' spread (the difference between average borrowing cost and average lending rates) increased by 0.21 of a percentage point. Accordingly, over a three-year period, the profit made by banks works out to $1.34 billion out of the wholesale funding guarantee alone - leaving aside the deposit guarantee.
Putting it another way, $1.34 billion is a taxpayer-funded subsidy for banks - mainly the majors, the main issuers of the debt.
The government now wants small financial institutions to pose competition to major banks after having done everything they could to benefit the majors. The major banks need to be made accountable. The solution lies in making the information on bank funding costs, lending rates, margins as well as fees and the international comparisons publicly available.
Milind Sathye is a professor of banking and finance at the University of Canberra and a deputy general manager of the Reserve Bank of India.
This story was found at: http://www.theage.com.au/business/lets-see-the-flip-side-of-bank-funding-costs-20100405-rn5q.html
Let us see the flip side of bank funding costs
http://www.theage.com.au/business/lets-see-the-flip-side-of-bank-funding-costs-20100405-rn5q.html
Saturday, June 5, 2010
Small Business Finance
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)
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)
Friday, November 28, 2008
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