Many small businesses looking to grow find it hard to access finance. Lenders say that they are keen to lend to small businesses, but that unsecured finance involves more risk. This article outlines some initiatives that could help to improve access to finance for small businesses.
Issues with Obtaining Finance as a Small Business
The proportion of small businesses that find it relatively easy to access finance has declined recently, with around one-fifth reporting they’ve found it difficult to access finance.
While interest rates on business loans are near historic lows, there continue to be differences between the rates paid by small and large businesses, with the following key issues identified:
- Banks are reluctant to finance start-ups given the high risks involved. Entrepreneurs often resort to using personal credit products (such as credit cards) to fund their day-to-day operations when they start their business.
- Banks are reluctant to extend finance without real estate as collateral, meaning that many entrepreneurs delay expansion until it can be funded from retained profits.
- The process to obtain finance is lengthy and onerous. Banks are reluctant to provide small business owners with advice on how to obtain finance and while innovative non-bank lenders are offering products with streamlined application processes, the interest rates on these products are often very high.
- Some large businesses require small business suppliers to accept payment times well beyond 30 days.
Lenders’ Face Increased Scrutiny
The banks’ lending to small businesses has grown in recent years though still slower than their lending to large businesses. This is partly due to the increased scrutiny of conduct in the financial services sector that has extended to lending to small businesses. Banks have tended to apply the rules for consumers to small businesses, contributing to the issues of the loan application process.
In response to increased scrutiny, the industry associations have been updating their standards with the ABA’s new Banking Code of Practice to provide additional protections for small businesses. Also, a recently released a Code of Lending aims to improve the transparency of the products offered by the lenders.
Improving the Financial Capability of Small Businesses
Lenders are concerned about the low level of financial capability of small businesses applying for finance. If these businesses improve their accounting processes, better evidence of their financial performance when applying for loans.
Many small businesses are unaware of factors that can affect lenders’ assessments of their creditworthiness. For instance, a small business owner’s credit score will be lower if they have previously applied for multiple personal credit products. This could be addressed through providing information about the factors affecting creditworthiness when an entrepreneur first registers their business, and when small businesses lodge their tax statements.
Another issue is that many small businesses do not pay their tax on time, and use this as a relatively cheap form of finance, unaware that unpaid tax debts negatively affect assessments of their creditworthiness, and make it more difficult to obtain bank finance.
Providing Lenders with Better Information
The comprehensive credit reporting regime for consumer lending will provide lenders with more ‘positive’ information about a large number of potential borrowers. Previously, lenders only made ‘negative’ credit information about their customers available, such as loan applications and defaults. Legislation was introduced last year implementing a mandatory regime whereby the major banks will be required to supply information to the credit reporting bureaus.
The introduction of an open banking regime will make it easier for individuals and small businesses to share their own transaction data securely with third-party service providers, such as potential lenders. The Australian Government recently announced that it will phase in open banking, with the major banks to make data on card and deposit accounts available by July 2019, and mortgages by February 2020.
Better access for lenders to the financial data of businesses would also help to improve access to small business finance. The credit reporting bureaus and some lenders are already collaborating with the major cloud-based accounting software platforms. These partnerships allow small businesses to share their financial data with potential lenders, simplifying the loan application process. Lenders and credit reporting bureaus have indicated that it would also be useful to have more access to ATO data on the finances of small businesses applying for loans, particularly to verify business income from tax returns.
Need Help Accessing Finance?
Some initiatives that could potentially improve access to finance for small businesses include comprehensive credit reporting, open banking and better financial record keeping. If you’re a small business owner and need some extra help obtaining finance for your business, contact me today.