This week, the Productivity Commission released a new research paper ‘Small business access to finance: The evolving lending market’. This study examines SMEs’ access to debt finance, which is the more common option sought by SMEs needing external finance. It focuses on the medium-term trends that are changing the market rather than the temporary disruptions due to COVID-19.
The PC research found that almost 15 per cent of Australian SMEs applied for debt finance in 2018-19, compared to only 5 per cent applying for equity finance. In 2017-18, most SMEs (69%) seeking debt finance applied to banks. While Australian banks remain the major source of funding for SMEs in 2020-21, banks have broadly shifted away from SME lending, partly due to tightening regulatory standards. Regulation has shaped the evolution of the SME lending market. Changes to prudential rules have made lending to SMEs less attractive for the major banks, creating opportunities for new and established non-bank lenders. Compared with mortgage lending, lending to SMEs can be relatively costly because of higher (regulated) capital requirements, more complex credit assessments and the higher risk of default. This shift has created opportunities for non-bank SME lenders, with few regulatory barriers to new lenders entering or existing lenders growing. A surge of new lenders and products into the market appears to be rapidly changing the options for SMEs. Innovative use of new technologies and data sources has enabled lenders to assess more accurately the creditworthiness of prospective SME borrowers.
The recent developments in Australia’s SME lending market are very significant. For some SMEs, the new lending options offer more convenience and allow them to respond quickly to business opportunities that might otherwise pass them by. For others, borrowing without property collateral may allow them to take entrepreneurial risks to innovate and grow their business. And, for some SMEs, the new options may mean that borrowing has finally become possible, as better information has allowed them to be distinguished from less creditworthy firms. More flexible options can only make SMEs better off but, for a small number of firms, it might lead to taking on higher levels of debt and greater risk.
While the SME market is well covered by various lenders and products, there appears to be a gap for unsecured finance between $250,000 and $5 million, with few lenders willing to offer these loans. The PC did not identified any regulatory barriers preventing willing borrowers and lenders from reaching a deal in this segment. It is likely that this gap stems from commercial factors.
While most SMEs are aware of banks as a source of finance, awareness of other options is more limited. SMEs may mistakenly expect difficulties accessing finance if they do not know the full range of products and lenders available to them. Proposed changes to Australia’s capital adequacy framework — which are expected to be implemented from January 2023 — could support banks’ SME lending activity in the future.
Compiling more detailed and comprehensive data on business lending — particularly by smaller lenders, as new entrants in the market tend to be — would allow researchers to undertake further analysis on recent and future market developments.
The full report is available at: https://www.pc.gov.au/research/completed/business-finance