Newsletter – November 2013

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The Profit and the Loss – The Abandonment of the Social Contract by Banks

In recent press we have all read about the ANZ Bank making a record 6.5 billion profit, Westpac 7.1 billion, and Commonwealth a nice $7.7 billion, whilst at the same time we also read of a record number of businesses going to the wall due to various reasons. One key factor that is driving businesses to the wall is the thinning cash flow positions and the lack of a financial line of credit to assist them through lean economic times.

The two statistics seem unrelated at first glance but in fact there is a deeper and subtle relationship between these two outcomes. The key lies in the fact that up until the last 20 years there was threaded through society a framework of institutions that served both a social and a capitalistic purpose.

Banks were one of the primary institutions of this nature. The 4 major banks were either government controlled and run or were bound by regulation that proscribed much of their behaviour. Banks assisted business through the reasonable supply of credit such that business in turn could continue to supply the community goods and services.

There was an implied or actual social conscience within these banks such that they had a charter and obligation to work with small businesses and consumers toward the common good of society. Banks worked to a profit maxim which was constrained by the obligation to be reasonable and to fulfil its social contract.

In any capitalistic society the access to capital for cash flow and expansion or growth is a key requirement for modern business. Banks and governments knew this and ensured that lending to both small and big business took place in a reasonable and sustainable way that allowed economies and societies to grow in a stable and sustainable way.

The social contract was that banks were gate keepers of the money and used a reasonable credit risk set of processes to ensure that business had the confidence to undertake its mission with the necessary access to credit as the need might have arisen.

In the 1980’s we saw in Australia the start of a gradual shift in the role of banks in Australia towards a more deregulated footing. Over time the banks took on a more shareholder driven orientation and quietly stepped back from the moral obligation and implied social contract to continue to lend under a social contract.

Globalisation and then the losses suffered by banks in the dot com bust and then the GFC crisis all occurred as the banking executive had its remuneration practices realigned to that which resembled truly international profit driven business outcomes.

The social contract gradually went missing over these years and governments also ceased to be able to reign in the banks as more offshore banks moved in to compete with local institutions. The net effect has been the deterioration in the community for small business in particular to get access to ongoing funding for their operations.

An ongoing pattern I have encountered in 2013 as a business coach from small business owners and potential start-ups is the difficulty in being able to successfully obtain business banking loans. Mortgage brokers also speak of this trend and there is now a real perception out in the community that banks are no longer interested in lending to small business, sole traders and partnerships, except where there is an absolutely no risk to the lender.

There is an opinion now that the big banks no longer feel obligated or even want to lend to small business. The idea is that they offer business lending products and people can apply but the credit risk management processes kill off all but the most profitable applicants.

Banks simply find it all too hard to understand individual businesses and so the profitable big end of town and very profitable small borrowers are now really only being catered for in business lending. This has and will continue to put pressure on existing small business and will slow the national economy as new businesses with good ideas find themselves unable to secure funding to start their business.

Every market responds to demand however and now we find a convenient distortion in the lending market which serves both banks and the borrower. Businesses are now being forced to apply for mortgages against their houses and use the funds for business purposes.

This new outcome is a bit murky as there is a mixture of positions now by various lenders with traps for the unwary lender.  For a start it is critical that potential lenders know that any attempt to lend via an application will be lodged against their credit history as that which can be found on credit reference sites such as Veda Australia.

If you apply and are successful then tick you get a good outcome on your credit history. If you apply and are rejected which is happening more and more as banks turn away from wanting to lend, then you are doubly punished by have a cross or negative strike placed on your credit history.

This outcome is punishing of the unwary and further undermines businesses trying to stay afloat or grow if they then end up with a bad credit history courtesy of lenders making it almost impossible to comply. The lender faces a double jeopardy now in the way our financial institutions are allowed to conduct themself with indifference to the fate of the lender.

 Mortgage Brokers such as Lun Lin of Victory Mortgages note that “lenders need to be aware of how the financial landscape works in Australia as it has changed since the pre GFC days when banks lent to many with few lending checks in place”. A mortgage broker is actually now a safer and better proposition for the average lender to engage with as they understand the labyrinth of new lending rules, processes and positions being taken by the industry and the various financial institutions.

Mortgage brokers have noted that some of the smaller banks will now basically lend to a small business owner if they process the loan against their housing asset as being the risk coverage to the loan. In this space some lenders want a statutory declaration about what purpose the lending is for while others do not apply that test.

In the end the small business owner is increasingly being asked to place their personal housing assets and equity on the line to secure finance for starting up or growing a business. The business itself is often not evaluated in this process as in the 21st century economy more businesses are digital asset based instead of traditional bricks and mortar.

The problem here is Australia is increasingly needing its Gen X and Y entrepreneurs to step up in the knowledge and smart economy and led the next wave of business innovation and success. This keeps employment moving ahead and creates new economic wealth.

However Gen X and Y are struggling to get a foothold into the residential property markets and for those that do, given the high median prices, there is not a lot of equity left for a bank to consider lending against. This bigger picture is disturbing as it undermines a generational trend of renewal that has existed up until recently and which has no obvious solution.

Some banks such as St George have recently pledged $2 billion for small business lending as it recognises the problem and strives to become the leading small business lender in the small business sector. They are creating new loan application hubs around Australia to deal with potential small business customers and staffing them with 50 new business lending staff.

The key will be how high St George places the hurdle that a small business must jump over to qualify for a loan. It is one thing to have a pot of gold beckoning small business to chase but it is another thing as to how friendly the credit review process will be to small business operators. It could be a mirage for many or a welcome change and only time will tell what the reality is of this offer.

Overall the social contracts that banks once held with the Australian community are basically dead. This one important lever of economic growth has gone and governments are now powerless to get banks to lend to any one sector of society or the economy.

Small business which employs more Australians than any other sector and which fills treasury coffers with GST and Sales Tax and payroll taxes are suffering under these outcomes. The long term decline of small business in Australia can be predicted where banks impose onerous lending criteria which only serves to protect banks and their shareholders.

The wider community stakeholders who banks once served are nowhere in sight in the new post modern era of banks as being just another capitalistic profit driven entity in our society.  Banks now report record profits without shame and their language is now all geared around shareholders and shareholder returns.

We are also now witnessing a transition occurring where we are finding that economic migrants are increasingly purchasing small businesses as they come into the country with finance and assets ready to buy without necessarily needing to lend from Australian financial institutions. We are seeing now a change of demographic of ownership in terms of who are becoming the small business owners in Australia.

This change brings some potential positive multi-cultural outcomes to society as the new owners bring new ideas, innovations and practices into these businesses. However there is also the possibility that a lack of understanding of Australian laws and practices may not be understood and adhered to as small business practice compliance is largely up to the business owner to inform themselves of.

We are at a time in Australia’s economic journey when many dynamics are changing. The traditional face of Australian small business is under challenge by many new forces.

The loss of the social contracts that once guided bank behaviour has made Australia a tougher business landscape. The result is there are more losers than winners.

More than ever you need proper and legal financial advice. When you seek advice ensure that for financial advice that person carries an Australian Financial Services Licence (AFSL), and for  tax advice make sure that the person carries a Tax Agents licence.

The governments and banks appear comfortable with this arrangement even though it undermines the fabric of our communities. It may over time increase business failure, personal bankruptcy, and unemployment as small business cannot fairly access capital needed to start and maintain their business operations.

For the full version of this article click The Profit and the Loss – The Abandonment of the Social Contract by Banks

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