Are consumers and small business facing a credit crunch?

There are plenty of stories on the topic of a Royal Commission-driven credit crunch right now, and not all of them are based on fact.

Could the Australian Banking Royal Commission lead to a credit crunch for small business and consumers?

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has not yet ended, but the arguments about future regulatory issues have already begun. One of the biggest issues is around a potential credit crunch affecting small business loans and consumer mortgages. The likelihood of such a credit crunch, according to some, is increasing.

A recent report from a group of UBS analysts and economists, Could the Royal Commission Cause a Credit Crunch?, said that although the Royal Commission’s interim findings will not be released until September 2018, with the full, final report following in February 2019, banks will continue to address irresponsible lending. 

Already ANZ has suspended new retail asset finance loans for cars, boats and caravans, for instance, and Commonwealth Bank is taking various credit card and personal loan insurances off the table. 

On their own, such changes appear small. Yet as a collective they represent a shift in thinking, an increasingly risk-averse approach to lending that could have serious side effects.

Banks reduce lending to consumers

The UBS report says that as banks revert to undertaking a full assessment of each credit application, including a more thorough analysis of customers’ income, living expenses, assets and liabilities, and comprehensive credit reporting is rolled out, the flow of credit could be constrained. As a result, the housing market could slowly deflate.

Another scenario could see the benchmark household expenditure measure, an estimate of expenditure, lifted significantly.

This would cause a sharp drop in net income calculations and lead to “a sharp reduction in credit availability, especially for lower income households”.

Will there be a credit crunch?

There are plenty of stories on the topic of a Royal Commission-driven credit crunch right now, and not all of them are based on fact, says Martin North, principal of Digital Finance Analytics. Some claim the development of new or tighter regulation will cause credit issues, but North believes implementation of the current regulations will more likely change.

“The revelation from the Royal Commission is that across the industry, people are not complying with the current regulations that exist,” North says. 

“The mechanisms being used inside the banks, and between the banks and the brokers, are out of kilter with what is understood to be suitable guidance. That doesn’t mean the legislation is to change, it means that people need to be held accountable for obeying the law.”

Claims around the Australian Prudential Regulation Authority clamping down on credit and regulators causing a credit crunch, North says, are “nonsense”.

We should expect a credit crunch in mortgage markets and small business loans, he says, but it won’t happen due to new regulation. It will occur because lenders are finally being made to execute against standards that already exist.

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Credit crunch in small business lending

Glenn Otto, associate professor of the School of Economics at UNSW Australia Business School says the threat of a credit crunch for small business funding is real.

“A large percentage of SME (small-to-medium enterprise) finance comes via bank lending,” Otto says. 

“Corporates have other sources of operating funds, but SMEs do not. Therefore, if there was a tightening of rules around lending to small businesses, they wouldn’t have many outside options. That could have a significant effect on these enterprises.”

Small business owners, in particular, find themselves in a catch-22 situation because there’s an “asymmetric information issue”. A small business owner typically has enormous and deep knowledge of the business itself, of its potential, its opportunities, its growth prospects and its risk profile. A lender to such a business, however, likely has very little knowledge of its specifics and its prospects around risk and return. 

In order to counter this imbalance, some banks have developed specialist expertise in assessment of risk levels of small businesses within specific industries. BOQ, for example, has a BOQ Specialist arm that looks after those in the medical, dental and veterinary professions. However, not all professions are covered and, once again, if bank lending behaviour were to tighten, then all professions will suffer.

Solution to a credit crunch

Amidst darkening skies, what can a small business do? Moreover, how can their accountant help? As in most areas of business, Otto says, it’s about survival of the fittest. If a small business wishes to thrive, it has to be the best in its field. 

“Rather than raising interest rates, banks will typically ration credit more strictly. You want to be the business that gets the credit rationed to you, right? If a bank has a choice between a small business with a well-thought-out, clearly articulated and sensible proposal and one that’s not as good, then of course banks are more likely to lend to the one with the better proposal.”

If a small business that has good chances of success can work with its consultants, including accountants, to tell their story clearly and, as a result, earn finance from a bank, that’s good for everyone. It’s good for the business, it’s good for the bank and it’s good for the economy.

Read next: How will the slowing property market affect the economy?


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September 2018
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