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Trends reshaping the SME lending landscape: PC report

Changes in the lending landscape over the last decade have opened doors for a wide range of finance options available for small businesses that do not require property as security, according to a new analysis by Productivity Commission, Australia’s independent research and advisory agency.

The research paper called Small Business Access to Finance: The evolving lending market examined the evolving small business lending market and the many financing choices available. 

The research indicates that the recent emergence of new products has increased the loan options available to SMEs, thanks to a supportive regulatory framework.

Productivity Commissioner Catherine de Fontenay said in a statement that, while traditional SME loans are typically secured by property, lenders now have more confidence to lend to SMEs using various types of collateral due to improved supportive data.

“Every year, one in six small and medium enterprises (SMEs) seeks finance to fund and grow their business,’ Commissioner de Fontenay said.

“Traditional SME loans are usually secured by the property. But spurred by new technology and new data, lenders now have more capacity and confidence to lend to SMEs using other forms of collateral or even lending unsecured.” 

Why this study?

Small businesses, according to Commissioner de Fontenay, are critical to the Australian economy. “These businesses are the engine room of the Australian economy and a healthy small business sector is vital to the economy, especially as we recover from the COVID-19 pandemic,” she noted. 

Source: Commission estimates using data from the ABS

However, Surveys report that about one-fifth of SME owners say that a lack of funding is a barrier to their success. 

To put things in perspective, Australia has 2.4 million SMEs, employing over 7.4 million people and contributing over $700 billion to the economy as of June 2020.

What does the report say?

As per the report, 15% of SMEs applied for debt finance in 2018-19 for these reasons:

  • 47% Maintain cash flow
  • 41% Replace or upgrade existing capital
  • 32% New capital purchase
  • 31% General business growth
  • 27% Ensure survival

Banks issued up to 91% of SME debt. In 2018-19 SMEs sought debt finance from:

  • 69% Bank
  • 33% Finance company
  • 4% Other institutions
  • 8% Friends, family and others
  • 14% Existing owners of the business

A broader range of lenders and products are available to SMEs:

  • Neo-banks
  • fintech lenders
  • finance companies
  • Private credit providers

Additionally, products include not just property-secured lending but also borrowing using alternative collateral such as vehicles, machinery, and bills, as well as unsecured loans.

Over-reliance on debt finance

SMEs typically rely on debt financing, with debt being three times more likely to be sought than equity financing. In 2018-19, 15 percent of SMEs sought loan financing. Larger SMEs, as well as SMEs in agriculture and mining, had greater application rates. 

  • SMEs in primary industries (agricultural and mining) had the highest application rates, at 23 per cent. 
  • The application rate for SMEs in the logistics and supply chain industries was likewise reasonably high (18 per cent). 
  • In contrast, only 11 per cent of SMEs in knowledge service industries, such as information, financial, and professional services, asked for debt financing.
  • The most common reasons for obtaining debt financing were to preserve short-term cash flow (reported by 47 per cent) and to replace or upgrade existing capital stock (41 per cent). 
  • The majority of SMEs seeking loan financing successfully apply to Australian banks. Banks own more than 90% of the outstanding debt owed by SMEs. 

Closing the lending gap with AI

The report stated that, while some SME owners are concerned about their access to credit, a flood of new technology is entering the market, including reliance on Artificial Intelligence and Machine Learning to check the creditworthiness of SMEs. 

“While some SME owners worry about their access to finance, a surge of new lenders and products into the market appears to be rapidly changing the options for SMEs. Some of these options rely on emerging technologies that help lenders quickly assess the creditworthiness of SMEs,” the report said.

“Combining new data sources with innovative analytical tools (such as artificial intelligence and machine learning) has given many lenders the information and confidence to lend to SMEs without the security of property. 

“In other cases, lenders have taken a more traditional relationship‑banking approach, providing tailored services that were once the hallmark of the banks.” 

Higher lending costs for SMEs

Concerns regarding SME access to finance are not just about quantity, but also pricing – that is, if creditworthy SMEs are granted finance at a reasonable cost and on reasonable terms, the report noted. 

“Interest rates on business debt have fallen dramatically over the last decade, in keeping with the general easing of monetary policy, although small businesses pay higher interest rates than larger ones,” according to the report.

Source: RBA

While aggregate data on SME lending are scarce prior to July 2019, typical variable rates on outstanding small loans (business loans of less than $2 million) have fallen from around 8% in 2010 to 5% in 2019. 

Since 2019, the cost of debt capital for both small and medium-sized firms has continued to fall, though the disparity between interest rates paid by small and large businesses has slightly increased.

Changing landscape

While major banks remain the primary source of lending for SMEs, traditional and new lenders now provide a much wider choice of products. The financing market is becoming more competitive, according to the report, which can eventually lead to further improvements in SMEs’ access to capital.

“A broader range of products can provide SMEs with finance more quickly and flexibly, allowing them to seize opportunities. Some SMEs may even be able to borrow for the first time,” Productivity Commissioner Malcolm Roberts said.

SMEs may be unaware of all of their funding options and may be reluctant to try new models. Brokers can assist them in identifying the appropriate loan. New business models have generated a substantial change in the funding market for SMEs during the previous decade, the research said.

“Finding the right product may be challenging, but the benefits can be significant,” Commissioner Roberts said. 

Neo-banks and fintech startups

Throughout the pandemic, new fintech lenders have emerged, as well as existing operators looking for novel solutions to assist business owners in obtaining funding. BNPL company Zip Co, for example, started offering split payments to businesses, in April this year. 

Similarly, BankiFi, a technological platform, announced its entry into the Australian Financial Services industry. BankiFi’s technology platform enables fast money transmission, allowing small and medium-sized firms (SMEs) to avoid common issues such as late payment and other cash-flow challenges.

Download the report here: https://www.pc.gov.au/research/completed/business-finance/business-finance.pdf

Download the infographic here: https://www.pc.gov.au/research/completed/business-finance/business-finance-infographic.pdf

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