Institute of International Finance Conference, G20 Sydney
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Small businesses and family enterprises are fundamental drivers of jobs, of innovation and growth in our country as it is in yours. Access to affordable finance is the oxygen of enterprise and along with human capital and the accessibility of markets, is one of the primary preconditions for enterprise and the kind of growth that I am here to talk about.
A World Economic Forum Report recently released in January found funding and finances were the second most important factor to growth and success of Australian enterprises. Small businesses need good access to affordable finance to start and grow and the financial sector needs to step up and help deliver for small business.
This conference and G20 deliberations that follow represent my key pivot point. The policy framework and regulatory focus need reframing, beyond the GFC crisis response and harm abatement mode, to focus on embracing the imperatives and jobs for growth and prosperity alongside system stability, robustness and certainty.
A contemporary framework, about both managing risks and doing business where our financial system framework and its domestic implementation are more of an enabler of enterprise. For us and many of us gathered here, small business is the engine room of our economies. But is it getting the fuel it needs? What role can we play to support a renaissance in enterprise? Small businesses have a smaller range of options for securing finance for their businesses, particularly when they are compared to larger enterprises.
Disclosure requirements and other regulations as well as smaller amounts of funds that small businesses need, means the traditional equity markets are not a realistic option for most.
Small business operators like to maintain control of their business – it is their baby. They put their heart and soul into every waking moment of it, and that’s often a difficult pre-condition when seeking equity.
Small businesses find it harder to access finance than larger business, with small business loan applications being rejected at roughly twice the rate of medium size businesses. What this means in Australia is that 7,000 small businesses each year have their loan application rejected, that’s in addition to those who are simply frustrated, discouraged or overwhelmed by the process of securing finance.
Often small businesses find it hard to understand what the financiers are actually expecting of them and this can discourage them from progressing with their quest for finance.
The good news here in Australia, is that the Australian Bankers Association are working alongside our small business organisations to try and make applying for a loan easier for a smaller enterprise. But there are fewer providers of small business finance, as some lenders particularly banks are branches of foreign banks, are focused on larger businesses. This is because small businesses are more entrepreneurial, they deal in niche and service industries, in markets that might be poorly understood by finance providers.
Small businesses also face higher interest rates than larger businesses, which makes finance less affordable. The average rate on outstanding small business credit is 205 basis points higher than for a larger business and 85 basis points higher than the standard variable home loan rate. And this has increased; it’s actually widened since the GFC. The small business loan spreads relative to the cash rate have increased by more than 200 basis points, compared to 140 basis points for larger businesses and 165 basis points for home loans. Many small business loan applicants are required to offer their homes and for many it feels like the banks want their first born child as well.
This is because the banks are unwilling to lend at affordable rates and many small businesses don’t provide that kind of security, even though business default rates are falling from the post GFC peak. We want to change that and together I think we need to change this. We need a lending environment where families have not the obligation or the essential need to put up their homes. To put their housing on the line to obtain finance would lead to more entrepreneurial activity in Australia and in your countries as well.
And the drying up of the securitisation markets during the GFC has also constrained access to finance, although here in Australia the situation is not as critical as it is in Europe.
Prudential regulation affects access to finance. We need to get the balance right between entrepreneurship and regulation. Whilst the risk weight for residentially secured small business loans is up to $1 million and are treated the same as home loans – the banks still charge more for a small business loan. Banks need to ensure that they are appropriately pricing risk, but let’s not have a predetermined view about small business and the risks that accompany their entrepreneurship.
In our country APRA’s standardised risk rates for unsecured business loans are the same for the large corporates with a similar credit rating. That sounds encouraging but let’s look a bit deeper because APRA itself has noted that small businesses are at a disadvantage because most small businesses don’t have a credit rating. The small banks and the non-bank lenders have been hit hard during the GFC. Since the GFC non major bank lending share of business in Australia has fallen by around 10 per cent. We need to ensure second tier and non-bank lenders are not unfairly disadvantaged by prudential requirements including capital requirements. Banks require proven financials when they provide finance. How do we do that for a start-up? Where are those proven financials? It is a start-up and this makes it hard for start-ups to generate finance and more so is a constraint on the entrepreneurial spirit. Well just under 90 per cent of small business finance applicants are accepted and gain access to the finance they are seeking. This could be much lower, around 70 per cent for start-ups and that inability to secure finance is a strong disincentive for anyone looking to start a business.
The good news is in Australia our major banks are alert to the opportunity, the delicious world of opportunity in the sector. They are indicating a greater preparedness to lend to small business including start-ups. Now we need more competition in this space to bring down the cost of finance for small business. Crowd sourcing equity funding is another option to potentially increase the available pool of funding for small business.
But this method of capital raising can be shaped, we think, to give investors more opportunities to make longer term investments in small enterprises and start-up firms. Encouraging small business loan securitisation could also prove to be an advantage in terms of access to finance in the small business community. But it is currently difficult to attract investors. Small business securitisation products struggle to obtain those all elusive credit ratings.
But other businesses can also play a role in helping to finance small businesses. They can step up and provide finance where there’s a supply chain relationship or some co-dependency where a bank is unwilling to do so.
Venture capital is an important form of private equity that provides finance to early staged, high potential start-up companies. Yes it is an option for small businesses but very challenging if they can’t demonstrate the kind of performance history often required to back finance and also something that’s of great interest to venture partners and also being too small to actually raise capital in public markets.
Our Government has a number of programs in place to assist businesses. The Venture Capital Limited Partnership, an early stage venture capital partnership, provide certain tax breaks to grow new ventures. Commercialisation Australia provides funding for entrepreneurs looking to commercialise innovative intellectual property.
I am particularly interested in and a very strong advocate of employee share schemes. This is a way we can bring resources and expertise, build a stronger sense of shared purpose between the business and its people. It’s something our Government is committed to addressing, as concerns have been raised, of getting finance through employee shared schemes is harder in our country than it used to be.
We want to encourage people to start a small business. We want Australia to be the best country to start and grow these enterprises. Part of that is ensuring that affordable finance is available and is within reach of those looking to secure it. We need to partner with our regulators. We need to embrace some of the insights we have shared today and also identify were the impediments are so that we can remove them to support small business accessing finance. That collaboration will involve Government, will involve industry, will involve our regulators to develop the strategies that we need to overcome those impediments.
You’d be aware in Australia we are holding an independent inquiry into our financial system – we want to make sure our financial system meets the needs of its users and that includes small business.
We’ll be looking into competition and innovation in the financial system – both critical to small business to see whether other red tape and compliance burdens stand in the way of our goal.
The G20 recognises the challenges of small and medium sized enterprises. Investing in SMEs is where the G20 is focusing on boosting private sector led growth, along with investment in infrastructure. Many countries, many of you in this room can identify SMEs facing difficulties accessing finance. Domestic policy action has been taken in some jurisdictions and this is worth examining to see what we can learn and transport. Difficulties have been exacerbated by the GFC due to a heavily reliance on bank funding and financing and a tightening of credit issues.
If we accept the importance of SMEs as a crucial source of growth, there is the potential for more positive policy action to mitigate the credit constrained environment SMEs are currently operating within. We’ve seen some examples in Canada, the United Kingdom and the United States – access to finance has been encouraged for small business through partial or full loan guarantees and co-financing.
In those jurisdictions the Government feels sharing the risk of the loan with the bank will contribute to a private sector willingness to lend. In Europe we’ve seen some examples where guarantees for mezzanine finance, which is a hybrid financial instrument which has a mix of equity and debt, is something that is designed to drive access to finance in the EU. One billion dollars of funding is in the European Investment Fund’s mezzanine facility which is designed to support and drive growth through investment in the debt and equity hybrid.
In Korea, the Government is providing direct lending support to small business and these are two examples we can canvas and explore and see where there are opportunities to broaden this experience.
I welcome the opportunity to speak with you today, to canvas with you the opportunity for the finance system, to be a positive contributor to the ambition of growth and jobs and prosperity, not only in our economies but more broadly.
What can we do to encourage entrepreneurship by improved and responsible access to finance for small business? What can we do together to sustainably improve that setting, to make sure that oxygen of the enterprise that drives jobs and innovation and growth within our economies, is within reach? What are the practical action steps we can take to ensure regulatory consistency, predictability and proportionality – a right sizing if you will – of that safe guarding environment and policy setting.
But at the same time, to ensure that the financial system can make its best contribution to a sustainable and supportive enterprise eco-system, that can help drive jobs and prosperity. Our economy needs that setting to be improved, I understand your’s do as well – what can we do to bring about that change so the oxygen of enterprise is more within reach of our enterprising citizens?