‘More debt is not the solution’: Why the government’s COVID-19 loans scheme is unlikely to ever work

recession

Treasurer Josh Frydenberg.

After three months, just four per cent of the $40 billion available under the federal government’s COVID-19 loans scheme has found its way into the hands of SMEs.

Recognising this the government has decided on three enhancements:

  1. The term of guaranteed loans can be increased from three to five years;
  2. SMEs can now borrow up to $1 million, from the previous $250,000; and
  3. The purpose has been expanded beyond working capital to include “investment”.

Not surprisingly, the big banks have offered their support for these changes. Commonwealth Bank chief Matt Comyn said the expanded scheme would give businesses a deeper pool of financial support.

“The changes will make it available to more businesses, for longer, to help them rebuild – and support Australia’s recovery,” said NAB boss Ross McEwan.

Why the loans scheme didn’t work

There are two very simple reasons why the scheme has not worked to date and these same reasons explain why it is unlikely to work any better in the future.

Firstly, SMEs are reluctant to borrow when they don’t know when this pandemic will end, and no-one knows when this will be, especially if you live in Victoria.

“The expanded scheme will allow businesses to access more credit for a longer period of time,” said Treasurer Josh Frydenberg.

If they are reluctant to borrow up to $250,000 for up to three years, why would they be more inclined to borrow up to $1 million for up to five years?

And it doesn’t matter whether the purpose is working capital or a long term investment. Until businesses can see a future, they will remain reluctant to borrow.

Secondly, banks don’t want to provide unsecured debt to businesses that may not survive. If they don’t want to lend up to $250,000 unsecured for up to three years, why would they want to lend more unsecured money for a longer period?

According to Australian Bankers’ Association chief Anna Bligh, the changes will “open up the scheme to more small and medium businesses needing help”.

The reality is that for most SMEs, more debt at this time is not the solution.

And expecting banks to provide more unsecured debt to businesses that may not survive is not in anyone’s interests. Offering a guarantee for half the loans written has not induced banks to lend more than they would otherwise have done.

What about the fintechs? 

The coronavirus SME loans scheme is better suited to fintech lenders because they have the appetite and technology to provide unsecured loans to the bottom end of the SME market. Yet, the total value of scheme loans written by these lenders is estimated to be less than $100 million compared with the banks total of $1.6 billion.

This is not so much due to lack of lender appetite, or even SME demand, but the difficulties faced by smaller and newer lenders in ensuring their own funding arrangements align with the scheme.

In addition, it has understandably taken some time for the regulators to fully understand and get comfortable with the modus operandi of these lenders, which function very differently to traditional lenders.

Interestingly, the sceptics predicted an economic downturn would prove to be the undoing of fintechs that lend unsecured to lower quality SME borrowers. The counter view is that this would create the opportunity for fintechs to reinforce why they are becoming an increasingly significant alternative source of funding for SMEs.

Time will tell, although it can be said that the changes to the scheme are unlikely to make much difference to the fintechs because they generally prefer to lend smaller sums for shorter terms than the banks.

So, where do we go? 

As everyone acknowledges, there are no easy answers. Many SMEs will not survive and as harsh as it may seem, we need our banks to continue to be upfront on this.

A concerted effort must be made to help existing SMEs survive and prosper and to encourage a post-corona boom in the creation of new businesses.

Debt is only a one part of the equation. Small businesses often need equity more than they need debt. Tapping into superannuation funds is an important source of equity and we need to super charge the $2 billion Australian Business Growth Fund.

We also need to improve the understanding of small business owners about the very different roles played by equity and debt in establishing and growing a business.

Tinkering around the edges of the coronavirus SME loans scheme to enable lenders to offer more debt for longer terms is not where our focus needs to be. There is much more that can, and needs to, be done by business and government to support long-term growth of SMEs.

A recent report commissioned by NAB identified eight key actions that can be taken to support and boost SMEs:

  1. Making it easier to hire new staff;
  2. Cutting regulation;
  3. Ensuring small businesses are paid faster to increase cashflow and access to working capital;
  4. Harnessing the power of digital tools;
  5. Opening procurement opportunities;
  6. Further access to different types of capital;
  7. Lifting small business management capability; and
  8. Improving state business conditions.

If we can to make real progress in these areas, Australia’s embattled SME sector could become the primary driver of the recovery and herald a new era of national prosperity.

This article was first published on LinkedIn.

NOW READ: Government-backed COVID-19 loans extended, now worth up to $1 million

NOW READ: Money in your pocket? What the $105 billion lending boost means for small business

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