A means to improve access to capital

Vicki Stylianou

Affordable finance is a critical factor for the future prosperity of your SMSF clients.

In the Institute of Public Accountants/Deakin University small business white paper, we explore how to boost small business productivity by enabling access to debt and equity capital. We consider the rationales for government intervention, which are, firstly, that small to medium-sized enterprises (SME) are able to generate positive outcomes by creating new jobs, new ideas and new abilities that other industries and the economy as a whole may enjoy (known as the spillover hypothesis). The second rationale is to address the existence of market failures, such as inadequate access to resources where viable SMEs may be at a disadvantage due to their size.

The key findings of our research are:

  • On average, 28,000 Australian businesses a year face a binding finance constraint, while 118,000 face some access to finance issues.
  • The focus of investment has shifted from investments in new productive capacity and efficiency enhancements towards more basic survival and liquidity-related expenditures.
  • By comparable international standards, the cost of debt is high in Australia.
  • Australian lending banks are cautious in their general lending policies and risk-adjusted lending is not the norm.External equity is of particular relevance for those high-growth/high-potential young businesses, where the current revenue capability cannot sustain a guaranteed payment of loan interest, thereby ruling out debt finance.
  • Governments with a strong commitment to economic growth via research and development investment are faced with a direct choice. They must find a means to ensure early-stage finance remains available to high-potential young firms or risk a reduction in the new commercialisation opportunities stemming from national investments in science and technology.

Our recommendation is that a loan guarantee scheme should be introduced, on a modest scale, for a trial period. Loan/credit guarantee schemes are widely used in many countries and have been a long-standing public policy mechanism for supporting small firms. We note Australia is unique in the developed world in that it has no guarantee scheme.

Well-established examples of these schemes include the SBA 7(a) loan program in the United States, founded in 1953; the Canadian core guarantee program, founded in 1961; and the United Kingdom’s Small Firm Loan Guarantee program, founded in 1981. A World Bank survey in 2008 identified loan guarantee programs in 46 countries, including France, Germany, Sweden, India, South Korea and Indonesia.

Critical indicators of the need for loan guarantee programs include a highly concentrated banking sector (few large banks); less dense local branch networks and a general lack of relationship banking; most commercial loans require assets to be placed as security; falling or stable asset values; a diverse entrepreneurial, and latent entrepreneur, population; access to loans is conditional on criteria not related to the quality of the entrepreneur or their investment proposal; the spread of interest rates on bank loans is narrow (indicating rationing is favoured over risk-adjusted lending); and there is substantial diversity in the relative quality of lending institutions.

Loan guarantee schemes have the advantage of being simple to design and administer and typically require that investment appraisal is conducted on a commercial basis. As a tool for promoting local economic development, loan guarantee schemes have been shown to be relatively successful as a means of public policy intervention.

As a guideline, the typical range across these core parameters for established loan guarantee schemes are: guarantee 65 per cent to 85 per cent; interest rate premium 0.5 per cent to 2.5 per cent; loan size, minimum $8000, maximum $500,000; loan term one to 10 years; arrangement fee, 0.25 per cent to 3 per cent of the total loan value.

We conclude there is a case for the design and implementation of a loan guarantee program in Australia to correct for the specific problems of smaller businesses being unable to finance new investment opportunities through normal commercial bank channels. But the specific scale of potential program demand needs to be established in a detailed feasibility study as this will determine the scale of the initial and ongoing demands on the government. Of course, other sources and programs, like crowd funding, also need to be encouraged and supported.

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