SME – Page 8 – Digital Finance Analytics (DFA) Blog

Yes, SME’s ARE Getting The Damp End of the Stick from the Banks

An inquiry into small business loans by the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell, has found the big four banks consistently engage in practices that have caused significant harm to some small business customers. The ASBFEO inquiry investigated a selection of cases examined as part of the Parliamentary Joint Committee Inquiry into the Impairment of Customer Loans.

This report confirms what our SME surveys show – small business has an unequal relationship with their banks, have difficulty getting the finance they need on fair terms, and find that lenders bully them especially in times of hardship. That said, SME’s often are unable or unwilling to shop around to get better deals, and feel trapped by the current arrangements. You can a video on our analysis here, and get the free copy of the DFA report here. SME’s are a critical engine in the economy, and current banking behaviour towards them is a brake on growth.

The ASBFEO report has made a significant number of recommendations.

Strengthen the Australian Bankers’ Association’s six-point plan;
Code of Banking Practice be revised to include a specific small business section, with the Code to be approved and administered by ASIC;
No defaults on loans below $5 million where a small business has made payments and acted lawfully;
A minimum 30-business day notice period for potential breach of contract conditions;
A minimum 90-business day notice period for bank rollover decisions for loans below $5 million (longer for rural properties and complex businesses);
Banks required to provide a one-page summary of loan default triggers;
Banks to put in place a new and clearly written small business standard form contract;
Borrowers be provided with a choice of valuer, vauler instructions and valuation report;
Borrowers be provided a copy of instructions given to investigating accountants and the subsequent report;
Banks to eliminate perceived conflict of interest when investigating accountants appointed as receivers;
An industry-funded one-stop external dispute resolution body, with a unit dedicated to resolving small business disputes regarding credit facilities of up to $5 million;
Bank customer advocates be made available to consider small business complaints;
External disputes resolution schemes be extended to include disputes with third parties appointed by the bank and to borrowers who have undertaken farm debt mediation.
A national approach to farm debt mediation;
ASIC to establish a Small Business Commissioner.

The ASBFEO inquiry – completed in just over three months – investigated the circumstances surrounding a number of cases of alleged small business mistreatment by the banks, and concluded loan contract arrangements between banks and small businesses, put the borrower at a distinct disadvantage.

“Fundamentally, what we’ve found is that small businesses who take out a loan, do so under the impression that if they keep up their payments, they will stay out of trouble. The reality is that this is not the case; that the clauses contained in standard small business loan contracts give banks an inordinate level of power over the borrower, who has zero ability to do anything about it,” Ms Carnell said.

“Basically, the terms in these contracts allow the bank to take action to protect itself from financial risk, by inflicting added demands on the borrower.

“For example, banks may conduct a new valuation on the assets securing the loan. Now if the value is found to have fallen, the borrower faces significantly increased – and potentially unmanageable – loan costs. Banks also have the power to unexpectedly call in the loan, and demand repayment in an unrealistic timeframe.

“So what ends up happening is that through no fault of their own, small businesses could quickly find themselves in default, even though they’ve made each loan payment, on time, every time.

“The banks argue that they don’t use these contract clauses, however our inquiry found this is simply not true; that banks do in fact utilise these clauses, much to the surprise and heart-break of their small business borrowers,” she said.

Ms Carnell said the ASBFEO report outlines recommendations that can be implemented – many in a short timeframe – to help alleviate the vulnerability of small business borrowers when entering contracts, while not impacting on the financial viability of the banks.

“The cases we examined during our inquiry highlighted the glaring need to ensure small business bank customers are provided with simple standard contracts that are written in plain English and that get rid of the clauses giving banks all the power,” Ms Carnell said.

“It’s also clear from the cases we looked at, that current thresholds governing small business external dispute resolution are insufficient, so we will certainly support work in establishing a mechanism to provide timely and affordable access to justice for cash-strapped small businesses,” she said.

Ms Carnell said the ASBFEO will publish six monthly scorecards on the progress banks are making in response to the recommendations contained in the ASBFEO report.

“Since the GFC there have been 17 inquiries and reviews that have produced more than 40 recommendations over the years, relating to the small business sector. Despite this, the banks have consistently failed to implement changes to address persistent problems” Ms Carnell said.

“Frankly, the banks take ‘kicking the can down the road’ to new levels. This is no longer acceptable and I’m determined the recommendations we’ve made are adopted as quickly as possible. This report is a living document; it’s only the beginning of our work in this area,” she said.

Ms Carnell said she hopes that as industry leaders, the four major banks will seize the opportunity to be exemplars for change, saying the ASBFEO has already secured varying levels of in–principle support from the banks on a range of issues.

“While there’s certainly a lot of work to be done, it’s important to give credit where it’s due, with the big four banks committing – albeit to varying degrees – to make changes in a number of problem areas identified during our inquiry process,” Ms Carnell said.

These include amending the Code of Banking Practice to provide greater small business protections, the creation of customer advocates and improved transparency on valuations.

Background:

On 6 September 2016, the Minister for Small Business, the Hon. Michael McCormack MP, tasked the ASBFEO with undertaking an inquiry into the adequacy of the law and practices governing financial lending to small businesses.

The ASBFEO inquiry investigated a selection of cases examined as part of the Parliamentary Joint Committee Inquiry into the Impairment of Customer Loans.

Throughout the inquiry process executives from the four major banks were summonsed to attend public hearings, with the ASBFEO using its Royal Commission-like powers to compel banks to produce required case documentation. The inquiry also heard evidence from bank customers during private hearings, and considered the findings of previous inquiries and reviews.

The Financing of Nonemployer Firms

From The St. Louis Fed Blog.

Nonemployer firms that applied for financing were more likely to operate at a loss, according to the recently released 2015 Small Business Credit Survey: Report on Nonemployer Firms.

This report, produced jointly by the Federal Reserve banks of St. Louis, Atlanta, Boston, Cleveland, New York, Philadelphia and Richmond, examined trends in businesses with no employees other than the owners. As the report noted, these businesses make up nearly 80 percent of all U.S. firms.

Applying for Financing

The report noted that 32 percent of survey respondents said they applied for financing in the previous 12 months. Among those who applied, the most common reason (66 percent) was to expand the business or to take advantage of a new opportunity. The next most common reason (38 percent) was to cover operating expenses. (Respondents could select multiple answers.)

Among those businesses that did not apply for financing, the top three reasons were:

Debt aversion (33 percent)

Already had sufficient financing (30 percent)

Believed they would be turned down (25 percent)

Profitability: Applicants vs. Nonapplicants

As the report noted: “Collectively, applicants were less profitable than the nonapplicants.” The figure below shows the difference.

Financing Approval

Among firms that applied for financing, 41 percent were not approved for any of the funding they sought. The percentages of firms not receiving any funding grew smaller as firms grew larger: 48 percent of firms with less than $25,000 in revenue did not receive any funding, while only 28 percent of firms with revenues greater than $100,000 did not receive funding.

About 71 percent of firms received less financing than the amount sought. When asked about the primary impact of this financing shortfall, the top response (33 percent) said the firm had to delay expansion. Other top answers were that they used personal funds (22 percent), were unable to meet expenses (18 percent) and passed on business opportunities (13 percent).

Additional Resources

2015 Small Business Credit Survey: Report on Nonemployer Firms

Micro firms make highest business complaints to ACCC

The Australian Competition and Consumer Commission’s latest ACCC Small Business in Focus Report reveals that micro and small businesses made 7,000 complaints and enquiries from July 1 to December 31 2016.

“Over 60 per cent of business contacts were from micro enterprises of four or under employees, which isn’t surprising given that micro firms are the biggest group of businesses in Australia,” ACCC Acting Chair Dr Michael Schaper said.

“In the past six months, the SME sector has been particularly concerned about misleading conduct and false representations with 735 complaints, consumer guarantees issues with 329 complaints, followed by misuse of market power concerns with 95 complaints.”

“Fewer franchisees have been reporting issues to the ACCC since the introduction of the new Franchising Code in January 2015. After an initial spike averaging 52 franchising complaints in the first six months of 2015, complaints have fallen to 32 a month by the end of 2016,” Dr Schaper said.

“The ACCC received 185 complaints from small businesses in the agriculture sector, a substantial increase from the previous six months. In the July to December period, the cattle and beef market study interim report was released, our dairy inquiry began, we conducted the first round of audits of signatories to the Food and Grocery Code, and our report into the horticulture and viticulture sectors was also published.”

Other key developments in the past six months:

Unfair contract terms provisions were extended to small business standard form contracts on 12 November 2016. We received 81 contacts about B2B UCT issues.

$1.395 million was reported lost by the small businesses to scams, down from $1.606 million in the previous six months

The ACCC took action against ABG Pages for alleged breaches of the Australian Consumer Law in its dealings with small businesses

The ACCC took action against Morild Pty Ltd for alleged breaches of the Franchising Code

“This year, we expect that the ban on excessive payment surcharging for all businesses on September 1 will generate significant interest from the business community. We have prepared advice for small business on the new credit card surcharging laws, which I hope all businesses will consult,” Dr Schaper said.

“We will also be releasing draft findings of our market study into the new car retailing industry mid-year, a matter of interest to many small businesses who operate in the industry or rely on new cars for their work. Businesses will have an opportunity to make a submission on the draft findings when it becomes available.”

Are Small Business Bearing Some Of The Bank’s Interest Rate Risk?

An interesting working paper from the IMF was released today. Why Do Bank-Dependent Firms Bear Interest-Rate Risk? looks at the link between bank funding, floating rates and how this is transmitted to firms who borrow on variable rate terms. The paper concludes that banks do indeed transfer interest rate risks to firms, and this is especially so when banking regulation tightens.

Here is the summary:

I document that floating-rate loans from banks (particularly important for bank-dependent firms) drive most variation in firms’ exposure to interest rates. I argue that banks lend to firms at floating rates because they themselves have floating-rate liabilities, supporting this with three key findings. Banks with more floating-rate liabilities, first, make more floating-rate loans, second, hold more floating-rate securities, and third, quote lower prices for floating-rate loans. My results establish an important link between intermediaries’ funding structure and the types of contracts used by non-financial firms. They also highlight a role for banks in the balance-sheet channel of monetary policy.

Here is the full conclusion from the report:

Bank lending is in large part funded with floating-rate deposits. As hedging is costly, banks avoid mismatch with the interest-rate exposure of their liabilities, in part, by making floating-rate loans to firms. To establish this link between the structure of bank liabilities and the floating-rate nature of bank lending, I examine the cross section of banks. Banks with greater interest rate pass-through on their deposits hold more floating-rate assets: both loans and securities. In the cross section, these floating fractions are positively correlated with each other. I show that if banks were responding to demand for floating-rate debt from firms instead of their own liabilities, this correlation would be negative.

Moreover, while banks with more deposit pass-through hold more floating-rate loans, they quote lower interest rates for ARMs relative to FRMs. The combination of higher quantities and lower prices points to variation in supply rather than demand. I also present time series and historical evidence supporting the supply-driven view of floating-rate bank lending to firms.

This paper therefore highlights an important consequence of banks’ short-term funding: the potential for interest-rate mismatch. While standard models do analyze maturity mismatch created by short-term funding, they typically do not consider uncertainty in interest rates and interest-rate mismatch.

This paper shows that the structure of banks’ funding has important implications for the choices banks make about interest-rate risk on the asset side of their balance sheets. More broadly, my results establish an important link between intermediaries’ funding structure and the types of contracts used by non-financial firms. My results suggest that tighter regulation of banks’ exposure to interest rates might lead banks to pass on more risk to firms, which is particularly relevant given renewed regulatory focus on banks’ exposure to rates.

Bank-dependent firms, i.e. poorly rated firms and smaller firms, are more exposed to interest rates than firms with better access to capital markets. While these firms do use interest-rate derivatives to hedge this exposure, they do so only partially. I show that this exposure is a component of the Bernanke & Gertler (1995) balance-sheet channel of transmission of monetary policy. Banks therefore play a role in the transmission of monetary policy to firms beyond the usual bank lending channel; here the effect is based on existing rather than new bank lending.

Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Innovative platform to help kickstart SMEs

Suncorp says it is making it easier to start a business in 2017 with the launch of Suncorp Start Company.

Suncorp Start Company, a new online platform, brings together a diverse range of services and solutions to create a user-friendly guide for aspiring entrepreneurs.

Suncorp Customer Platforms Chief Executive Officer Gary Dransfield said the website connects customers with resources like legal and accountancy documents, business name registration forms and website development tools, which are essential to starting a business.

“It also provides access to educational tutorials, tips and plans to help recently established and trading businesses to take the next step,” Mr Dransfield said.

“Our research tells us that small businesses want to spend more time on building their business, not completing paperwork – early access to the right tools and information can set them up for faster success.

“With Suncorp Start Company we consolidated solutions from our partner companies and insights from customer feedback to develop a product which solves problems and helps to meet their needs.”

The new platform follows Suncorp’s partnership with 9 Spokes to bring to the market ‘Suncorp Business Toolbox’ – a business dashboard that enables customers to gain insights across their business.

“We know small businesses are busy. Suncorp is committed to making it easier for them to achieve their financial goals through solutions and services which are easily available as part of our new Marketplace strategy,” Mr Dransfield said.

How speeding up payments to small businesses creates jobs

From The US Conversation.

Speeding up payments to SME’s would have a major positive impact. Operating a small business, the backbone of the U.S. economy, has always been tough. The same is true in Australia, and cash flow is a major challenge, as data from our SME survey shows:

According to The Conversation, SME’s also been disproportionately hurt by the Great Recession, losing 40 percent more jobs than the rest of the private sector combined.

Interestingly, as my research with Harvard’s Ramana Nanda shows there’s a fairly straightforward way to support small businesses, make them more profitable and hire more: pay them faster.

A major source of financing

When a business is not paid for weeks after a sale, it is effectively providing short-term financing to its customers, something called “trade credit.” This is recorded in the balance sheet as accounts receivable.

Despite its economic importance, trade credit has received little attention in the academic literature so far, relative to other sources of financing, yet it is a major source of funding for the U.S. economy. The use of trade credit is recorded on companies’ accounting statements as “trade payables” in the liability section of the balance sheet. According to the Federal Fund Flows, trade payables amounted to US$2.1 trillion on nonfinancial companies’ balance sheets at the end of the third quarter of 2006, two times more than bank loans and three times as much as a short-term debt instrument known as commercial paper.

Recent news reports have highlighted the problem of slow payments to suppliers as large companies extend their payment periods, often with crushing results for small businesses.

Other countries have tried to reform the trade credit market, especially in Europe, where a directive was adopted in 2011 limiting intercompany payment periods for all sectors to 60 days (with a few exceptions).

In an earlier paper, I showed that requiring payments to be made within shorter time periods had a large effect on small businesses’ survival when it was adopted in France. Receiving their money earlier led them to default less often on their own suppliers and their financiers. Their probability to go bankrupt dropped by a quarter.

Accelerating payments

To learn more about the impact of such reforms in the U.S., we studied the effects of speeding up payments to federal contractors.

The QuickPay reform, announced in September 2011, accelerated payments from the federal government to a subset of small business contractors in the U.S., shrinking the payment period from 30 days to 15 days – thus accelerating $64 billion in annual federal contract value.

Federal government procurement amounts to 4 percent of U.S. gross domestic product and includes $100 billion in goods and services purchased directly from small businesses, spanning virtually every county and industry in the U.S. In the past, government contracts required payment one to two months following the approval of an invoice, with the result that these small businesses were effectively lending to the government – and often while doing so, they had to simultaneously borrow from banks to finance their payroll and working capital.

Our research shows that even small improvements in cash collection can have large direct effects on hiring due to the multiplier effect of working capital. On average, each accelerated dollar of payment led to an almost 10 cent increase in payroll, with two-thirds of the increase coming from new hires and the balance from increased earnings per worker. Collectively, the new policy – which accelerated $64 billion in payments – increased annual payroll by $6 billion and created just over 75,000 jobs in the three years following the reform.

To give an example, take a business selling $1 million throughout the year to its customers and being paid 30 days after delivering its product. It therefore has to finance 30 days’ worth of sales at any given time (or 8 percent of its annual sales). As a result, it constantly has about $80,000 in cash tied up in accounts receivable.

A shift in the payment regime from 30 days to 15 days means that the firm has to finance only 15 days of sales, or $40,000. And that would in turn help it eventually sustain $2 million in annual sales and double in size.

Holding back growth

These findings confirm the widely shared belief among policymakers and business owners that long payment terms hold back small business growth.

They also raise the question as to why the economy relies so much on trade credit if it costs so much in terms of jobs, and whether other policies might be undertaken to reduce it. An interesting follow-up policy to QuickPay was SupplierPay. In that program, over 40 companies including Apple, AT&T, CVS, Johnson & Johnson and Toyota pledged to pay their small suppliers faster or enable a financing solution that helps them access working capital at a lower cost.

It is likely that more information on customers’ quality and speed of payments would allow suppliers to choose whether to work with businesses that pay more slowly. So following a “name and shame” logic, companies might feel they have to accelerate payments not to be perceived as bad customers.

The broader impact

Would it make sense to sustain and extend this policy?

An interesting aspect of our analysis is that the effect of QuickPay depends on local labor market conditions. It was most pronounced in areas with high unemployment rates when it was introduced. Elsewhere job creation was limited.

The reason for this is that helping small businesses grow gives them an advantage over other companies operating locally. By hiring more, these small business contractors make it harder for others to do so. Unless there is unemployment, this crowding-out effect offsets the employment gains of the policy.

As such, such a policy will be effective in stimulating total employment only in areas or times of high unemployment.

Author: Jean-Noel Barrot, Assistant Professor of Finance, MIT Sloan School of Management

Bank of Queensland Completes $20 million acquisition

Bank of Queensland has completed the $20 million acquisition of Centrepoint Alliance’s premium funding business as it targets profitable niche lending says AAP.

Centrepoint Alliance Premium Funding, which makes about 30,000 loans annually to small and medium sized enterprises, is a bolt-on acquisition that will be rebranded as a new division within the lender’s existing BOQ Finance unit.

Bank of Queensland shares closed 11 cents weaker at $11.88, in line with the decline in the broader financial sector.

Ombudsman to call on banks to give small businesses three months’ notice before ending loans

From Smart Company.

Australian banks would be required to give small businesses at least three months notice before ending or substantially changing their loan, if a recommendation by small business ombudsman is adopted.

Australian Small Business and Family Enterprise Ombudsman Kate Carnell has been “forensically” examining how the big banks treat their small business customers since August and her report into the banking sector will be released tomorrow.

Read more: Should small business loans be capped at $1 million?

The report is expected to include a series of recommendations to the federal government, including changes to how much notice the banks are required to give their small business customers.

According to Fairfax, the recommended notice period could be up to six months for businesses with rural properties or complex structures.

“The reality is that business loans are regularly ongoing—you might borrow to buy a business or set up a business, you expand and pay some back, and then you borrow more,” Carnell told SmartCompany.

“Business loans are not like home loans. They are ongoing, they go up and down depending on where you are in the growth of your business. It’s a huge problem if a bank decides not to refinance.”

While the full details of the recommendation will be made available when Carnell’s report is made public this week, she said throughout the inquiry’s public hearings that this issue of communication is a matter that needs to be “addressed urgently”.

“What we found in a range of the cases we investigated, what’s happened is the business has been given the expectation that they will have a new loan or their loan will roll over, [and] discussions … have been positive,” Carnell says.

“And then, sometimes days before the loan is due to finish, they’ve been told that the bank has decided not to refinance.

“The dilemma is small businesses don’t usually have lazy money ready to pay the bank back. In a number of cases, it’s meant the company or business has been forced into receivership.”

This starts a domino effect for businesses, says Carnell, as the moment a bank decides not to refinance a loan, the business’s loan is in default and the interest rate on the amount owed can increase substantially.

“Not only are you having to repay money you don’t have, but the cost of that money increases significantly,” she says.

Businesses will then attempt to secure finance from another lender, but having a loan in default with the first bank makes that even harder.

Carnell says having enough time to secure a new loan, sell existing assets or restructure a business is critical in this situation.

“I think three months is the absolute minimum, but it will regularly take long than that,” she says.

“It certainly shouldn’t be shorter than three months.”

While Carnell is clear that lenders are well within their rights to choose not to finance particular businesses, she says the current 10-day notice period included in the Banking Code of Practice is “obviously not doable”.

Ombudsman grills bank executives on SME lending

From Smart Company.

Small and medium businesses can today and tomorrow tune in to watch executives from Australia’s big banks answer questions about their track record when it comes to SME lending.

The federal government gave Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell the task of “forensically” examining how the big banks treat their small business customers in August.

Carnell’s review will involve two days of public hearings, which kicked off this morning with representatives from ANZ.

Private hearings have already been conducted and Carnell and her team are in the process of finalising recommendations to government, having also examined individual cases raised by the Parliamentary Joint Committee on Corporations and Financial Services.

Carnell said on Monday the public hearings will involve questioning the banks on potential reforms to ensure small businesses are protected from unfair treatment by Australia’s banking system.

“A range of themes have emerged during the ASBFEO inquiry process, and a number of potential reform measures have been identified as significant and necessary to a robust relationship between financial institutions and their small business customers going forward,” Carnell said.

“We’re interested in hearing from the banks about their procedures in relation to loan contracts, dispute resolution services and the treatment of valuations, and we will press them on their willingness to change their approach to things like monetary and non-monetary defaults, and the role of administrators in relation to small business bank customers.”

Representing ANZ at this morning’s hearings is deputy chief executive Graham Hodges, small business banking general manager Kate Gibson and customer advocate Jo McKinstray.

One of the first topics of conversation was the $1 million turnover cap that ANZ has in place as a definition of small businesses, and whether this is an appropriate definition. The definition is in part based on ANZ’s retail credit model, as opposed to the wholesale credit model, which is in place for larger enterprises.

When asked if that definition is adequate, particularly when financial institutions in other jurisdictions like the European Union are considering doing away with a definition of a small business completely, Hodges said ANZ believes “the current definition broadly covers the section quite well”, with businesses then moving into brackets of up to $3 million in turnover, and between $3 million and $5 million, as they grow.

Once they reach those levels of turnover, they require an “increased level of sophistication to manage their accounts”, he said.

Carnell responded by saying her objective is to ensure SME banking definitions and practices are “understandable for a group of people that matter to our economy, who don’t have in-house lawyers, who don’t have an in-house accountant”.

“We’ve got to make the system as simple as possible,” she said.

“I understand banks needs to manage risk. I think the important issue here is manage risk, not avoid risk, and therein lies the balance.”

How to watch the hearings

A live stream of the hearings is available from the ASBFEO website here.

There are three options to listen to the proceedings: by calling in by phone, by listening to an audio stream, and by watching a live video stream.

SMEs Unlikely To Switch Banks

As we continue our series on the results of our SME surveys, we look at bank switching behaviour. Satisfaction levels with their banks are pretty bad, but there is something weird here, because whilst three-quarters of SME’s say they would consider switching banks, in practice they rarely do.

More SME’s are dissatisfied with their current banks. We see significant polarisation, with some feeling completely satisfied, and others completely dissatisfied.

An analysis at the segment level reveals that more established, larger businesses tend to be more satisfied, whilst smaller and growing businesses are generally less satisfied. Those borrowing are less satisfied.

The average number of bank products varies across the SME base.

However, on a segmented basis, larger businesses tend to have a greater number of products.

Around three quarters of SME’s said they would consider switching.

However, from the time with bank data, we see that most stick with their existing relationships.

Our analysis suggests three reasons for this. First, many perceive little or no differentiation between banks, so there is no point in switching. Second, their current bank has provided facilities which make it hard to switch, including secured loans, credit cards and payrole services. Third, some have sought to switch, but have been unable to replicate the current facilities they have from their current bank.

More generally, because time is money, many SME’s experience inertia, because they are focusing on their business, not their banking.