Small business finance

For small businesses seeking finance to secure loans, make payroll, manage inventory, or expand, the more options out there the better. However, the global financial downturn has made a significant dent in the small business lending market, resulting in a new competitive landscape. The GFC flushed many of the smaller non-bank lenders out of the market and despite improving economic conditions, many banks still remain cautious in their lending practices. Such is the difficulty facing small businesses in accessing credit, that a Senate Economics Committee conducted a study on the matter early in 2010. Chaired by Senator Nick Xenophon, the committee delved into some interesting aspects of the state of market competition for small business finance.

Extent of competition

The committee reflected the strong view that there has been a reduction in competition in the small business lending market since the onset of the GFC and that this had resulted in a reduction of price competition between the major lenders.

Prior to the economic slowdown credit was very cheap, which resulted in fierce competition between lenders.  However, the onset of the GFC did affect the competitive landscape. According to the Reserve Bank's submission to the committee, this easing of competition is to some extent cyclical:

"During periods of strong economic growth, banks tend to compete aggressively for business lending by cutting their margins and relaxing their lending standards. However, when the economic and business outlook is uncertain and loan losses are rising, as has been the case over the past couple of years, banks see the loans as being more risky and pull back a the Australian economy strengthens, there may be some incentive for new or existing lenders to expand their lending in this sector and compete away some of this spread."

In addition to the easing of competition between the major banks, the drop in the number of non-bank lending institutions was also identified as a restricting influence on the small business finance market. In 2007, lenders who are not authorised deposit-taking intermediaries (banks, building societies and credit unions) made up around 10 percent of the market. Following the GFC this figure slipped to about five percent.

The committee did make the point however that many of these lenders didn't survive the GFC precisely because they did not have sustainable long-term business models.

The costs of switching lenders

In their examination of the small business financing market, the Senate Economics Committee also considered the impact of the cost of changing lenders upon the small business sector. A submission from the Council of Small Businesses of Australia (COSBOA) made it clear that they thought reducing fees in this area would improve competition and the range of options available to small businesses.

In comparison to the UK and the US, early termination fees in Australia are approximately four times as high. In answer to this COSBOA stated that not only should these fees be reduced, it recommended that all bank account numbers should be portable, a move it believes would further improve a small business's ability to change lenders.

This proposal was noted by the committee who in its recommendations put forward that: "banks abolish exit fees on variable-rate loans. If banks do not do so by the end of 2010, then guidelines or regulations, or if necessary new legislation, should be used to compel them to do so."

Other options

Besides lowering exit fees and implementing portable bank account numbers, the idea has been floated that the Australian government should establish a state-owned bank built specifically for assisting small businesses and helping entrepreneurs. Canada has operated a state-run bank, designed specifically for this purpose, for the last 65 years. In the UK a group of financiers have recently stated that they will set up a bank to provide credit flows exclusively to small and medium businesses.

However, despite the merits of these schemes the federal minister for small business Nick Sherry has stated that the Australian government believes that lending decisions are best left to the financial sector.

Speaking to small business website StartupSmart in October 2010 Sherry stated: "The government's primary role is to get the broader economic settings right - as we have done in steering Australia through the global recession in better shape than virtually any other advanced economy."

Another recommendation that COSBOA put forward to the senate committee was the introduction of a cash loss carry back system. This system would see small businesses able to offset losses in the current financial year against prior years' profits so that they would receive a refund of tax paid in previous years. This system would enable small businesses that have hit a troubled patch but have performed will in previous years to continue trading.

For more information on credit sources, read 'Types of credit available to small business'>>

The problems small businesses face in gaining access to finance is a significant issue for the Australian economy. As of September 2010 there were 1.93 million active small businesses in Australia, representing 96 percent of all businesses and employing some 4.8 million people. These numbers clearly show that small business forms a vital part of the Australian economy. The global financial crisis showed however, that when it comes to securing finance, Australia's small business sector is quite vulnerable.

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