The Banking Code of Practice (the Code) issued by the Australian Banking Association (the ABA) is independently reviewed every three years. The 174 page review conducted by Mike Callaghan AM PSM – an economic consultant and 38 year veteran Treasury official – released on 3 December 2021, and available here, is the first review since the Hayne Royal Commission.
The Code applies to consumers and small businesses, the latter specifically defined as those with annual turnover of less than $10 million and fewer than 100 FTE employees, and less than $3 million total debt to all credit providers (whether fully drawn or not).
Recommendations impacting lending to small business
I have set out below the recommendations which relate to small business lending, together with my comments, in italics:
(60) Part 6 should be extended from referring to ‘lending to small business’ to cover ‘providing banking services to small business.’ The first commitment in this part should be for banks to assist small businesses with their banking services that are suitable to their circumstances.
BNPL products are blurring the line as to what is “lending” and what is not. The proposed recommendation will also make it clear that merchant (i.e., credit card clearing) and foreign exchange hedging arrangements are caught, which seems sensible and uncontroversial.
(61) While it will take time to incorporate the Pottinger Review recommended changes to the definition of small business in a revised Code following the triennial review, ABA banks should commit to introduce the changes as soon as possible.
The change referred to here is to increase the total debt threshold from $3m to $5m, so that larger small businesses are protected by the Code.
Significantly, this would further limit the ability of banks to enforce “non-monetary defaults” (i.e., defaults other than non-payment of principal and or interest). Currently banks use non-monetary triggers such as financial covenants to monitor the health of businesses with multi-year loans. If the use of non-monetary triggers is further limited, banks are likely to reduce loan tenor to a standard 12 months, at least for riskier customers.
(62) To help clarify what parts of the Code apply to small business, and to recognise there is a difference in the requirements for lending to small business and lending to individuals, the references to small business lending in Part 5 should be shifted to Part 6 of the Code.
A minor and sensible change
(63) The Code should specify that future earning capacity is taken into account when assessing a small business’s capacity to repay a loan.
Banks will be happy to explain to their customers that they take future earning capacity into account when assessing a loan, and in my experience, this is already well-understood, so this will not be a significant change.
(64) The Code should clarify that a bank’s approval of a small business loan will not be dependent on a third party (such as the small business’s accountant) certifying the capacity of the small business to repay the capacity of the small business to repay the loan.
Some banks ask their customer’s accountant to certify the capacity of a business to repay a proposed loan.
This creates problems where the customer is unwilling or unable to pay the accountant’s fees for doing so, or where the accountant forms the view that the business does not in fact have capacity to repay the loan. The solution as proposed, however, may convert conditional approvals into unconditional refusals.
(65) Banks should advise a small business if there is likely to be a delay in the initial indication of how long it would take for a decision, the reason for the delay, and give a revised estimate when a decision is likely.
Unexpected delays can sometimes be an important “soft signal” that a customer is not regarded as being as credit-worthy as they (or perhaps the front-line banker) believe. In practice this proposal is more likely to see lenders formally estimate the longest possible period, to simplify later management of turnaround times.
(66) Banks should commit that if they require additional information when considering a loan application, they will endeavour to ensure that this does not delay the time it will take for the bank to make a decision.
In my opinion rules that would hold lenders to fixed decision periods should be approached with caution! It is always quicker to decline a loan than to approve it, and this proposal risks a default “no” the day before the deadline, to ensure that the target is met.
(67) Banks should commit to tell small business the reason, if appropriate, as to why a loan was declined, along with what would be needed for the application to be reconsidered.
This proposal was pressed by the Australian Small Business and Family Enterprise Ombudsman. It is hard to see how it will result in anything other than generic broad-brush statements, with most businesses being told that “the bank could not be satisfied that the borrower could service the loan.”
The most significant recommendation is the proposal to extend the small business lending protections from $3m to $5m, and the larger small business borrowers affected by this may be frustrated if it makes it harder to secure longer term loans.
Other recommendations will result in loans being more speedily declined for less creditworthy customers, but it is hard to see them as major, or significant.
Lending to small business would remain conservative: reference to the decision of a prudent banker remains unchanged, and there is no sign of a specific invitation for lenders to “look through” (i.e., make allowance for) external shocks such as drought or flood, or most recently, Covid, which seems a missed opportunity.