Why our banks need to re-discover the art of SME lending
By Christopher J Tipler
PC Joe Penhale, the policeman in the TV show Doc Martin, is amusing because he gets everything so wrong. Behind the uniform and all the police jargon is an inadequate fool. We laugh, somewhat uncomfortably, because he portrays a stereotype that is all too common today.
In the government sector in particular, where there has always been an over-emphasis on process for its own sake, effectiveness today is often completely displaced by people going through the motions in what might be seen as the dance of the drones. We express frustration at the waste of our hard-earned money that this dance involves; at blind obeisance to regulations, at box-ticking that creates the pretence of best practice. Success equals failure plus a story.
What the dance involves, of course, is the substitution of laziness and passivity for thinking and effort.
The business sector is not immune, however, to this disease. We see the same laziness behind the attitude towards risk as control rather than opportunity. We see boards substituting empty governance processes for capability. We see a mindless emphasis on values that have no meaning, and we see the equally mindless CSR paradigm being substituted for a genuine strategic effort on sustainability.
In our banking sector the same disease has now thoroughly infected the approach to lending, particularly to small and medium enterprises (SME’s). This infection is creating major issues for our small business sector, which cannot grow without adequate funding. It is not doing the banks any good either.
When an SME seeks bank funding it can reasonably expect that the suppliers of credit will demonstrate commercial common sense. This would involve a willingness to consider the funding proposal objectively on its merits, to take into account the history of the business and the credentials of its owners and managers, and to attach value to an existing relationship. In other words, they would apply the traditional skills of the good business banker, with all the judgement normally associated with this.
Since the GFC, however, our banks have abandoned these principles in favour of quite irrational behaviour. This involves:
- A reluctance or refusal to attach much credibility to business plans, however well developed and plausible
- Almost no regard for the history of the relationship or the credibility of directors and managers. The term ‘loyalty’ seems to mean nothing
- A refusal to advance any funds unless loans are fully secured by real estate and directors guarantees.
- A related reluctance to attach any significance to working capital as security. This effectively means that ‘cash flow lending’ is dead
- Attaching strict covenants and very short review horizons to loan facilities
- A complex loan approval process where several bank people or functions (obviously including Credit) seem to have the right to say no, and the client manager has little influence over the decision
- Excessive documentation (one recent proposed facility for one of my clients involved a pile of documents more than three centimetres thick)
- Large establishment fees
- Interest spreads (the difference between the banks cost of funds and its proposed lending rate) often exceeding four per cent
In my observation, this behaviour means that many good businesses either choose to, or are forced to, soldier on without bank support. Lower economic growth is an inevitable consequence. Curiously, our smaller regional banks seem to have adopted the same overall stance as the big four; perhaps their relatively high-cost funding base has forced them to be more risk-averse than they would like to be.
My purpose here is not to admire the problem but to outline it and then suggest some broad solutions on both the borrowing and lending side.
If your business needs funding and has drawn a blank with the bank, here are a few suggestions:
- The best source of capital is better trading. Re-focus on this, particularly to sell harder, reduce costs and cut working capital. Be ruthless in turning slow moving stock into cash. Look at giving your debtors an incentive to pay earlier and your creditors an incentive to receive payment later.
- Make sure that you have presented your lending case to the bank in the best possible light. If you have been knocked back, find out precisely why then re-submit or put a better submission to another lender. Use you accountants to help you put together this submission (they are not there just to do your tax)
- If you have some large, good quality debtors, look at debtor funding (what used to be called factoring). Some of the banks (e.g. Bank of Queensland) offer such products and they are not particularly expensive.
The first task for our lenders is to appreciate that limiting lending to SME’s below optimum levels, as a result of poor processes, is simply to put a brake on their own profitable growth. So they need to re-discover the art of lending to SME’s and pursue that art vigorously. The way to do this is to ask ‘what does it mean to excel at profitable SME lending?’
This question should elicit a number of practical responses. They might conclude, for example, that it means:
- Streamlining approval processes
- Giving the client manager greater discretion to approve loans up to certain limits
- Changing the credit assessment process to place greater weight on historical relationship and the quality of the business principals
- Changing security requirements to allow lending against the working capital assets of the business (stock and debtors) provided certain other criteria are met
- Appointing additional, experienced, commercial lenders to be lending team leaders
The SME sector is incredibly important to the health of our economy. It accounts for three quarters of all active businesses, employs four million people and delivers about half of our GDP. For this sector to be held hostage by mindlessly risk-averse behaviour on the part of our banks is unacceptable. It is time for our bankers to demonstrate that they are worth the fat salaries they are paid by ending the dance of the drones and starting a new dance – the waltz of the loans.
Christopher Tipler is a Melbourne-based management advisor and author of Corpus RIOS – The how and what of business strategy. His web site corpusrios.com contains more material on this and related topics.