Australian Bankers’ Association (ABA) chief executive, Steven Münchenberg, says small business owners are not ‘losing out’ on interest rates, despite what many may think.
“There can be no doubting the media and political attention home loan interest rates have received in the five years since banks started moving rates independently of the Reserve Bank. This level of attention has left some small businesses wondering whether they are being overlooked, and overcharged, compared to those with a home loan.”
Münchenberg says small businesses point to the difference between the interest rate charged for a home loan and that charged for a small business loan – even when secured against a residential property - when voicing their concern.
“Instinctively, it would seem that the two loans, both secured against the borrowers’ homes, are fundamentally the same and should therefore attract the same interest rates.”
He says lending experience, however, shows the two types of loan don’t perform the same and that the consequences if a loan goes wrong also differ.
“The first difference is that the likelihood of a business loan going bad is much greater than that of a home loan. True, people lose jobs or have other difficulties that can result in a home loan getting into difficulty, but the chances of that are much less than the chances of a business loan failing. One way to see that is to compare delinquency rates between them.”
The most recent figures available (December, 2011) show business loans that were 90 days or more behind in their repayments accounted for around 4% of loans. On the other hand, home loans at the time had a 90+ day arrears figure of 0.7% - less than a fifth of the rate for business loans.
Business loans are significantly more likely to get into trouble.
Münchenberg says banks know that when a loan goes bad, they recover less of the debt from business borrowers than from households.
“On average, the bank loses more money from bad business loans than from bad home loans. This is the case even if the business loan is secured against the business owner’s home.
So there are two differences important to banks – a business loan is more likely to go bad and when it does, the bank is likely to lose more money.”
This in turn increases the risk of the loan and banks set interest rates, in part Münchenberg says, according to risk.
“The riskier the loan, the higher the price.”
He says the biggest effect of this was seen when banks increased the interest rates on business loans as the GFC unfolded.
“As the scale of the crisis and its potential implications for the Australian economy became clear, banks increased the price at which they were prepared to take the risk of lending to business. That they were right to be worried can be seen from those 90+ days arrears figures – these rose from around 0.75% of loans in mid-2007 to a peak of 4.5% in September 2010, a six-fold increase.”
Yet, the higher risk of small business loans has another implication, says Münchenberg.
“APRA…looks at that higher risk and requires banks to hold higher levels of capital to offset those risks. Typically, APRA requires a bank to hold three to four times the capital, or more, for a business loan than for a home loan of the same amount. That additional capital comes at a cost to the bank and therefore makes business lending more expensive, a cost that business customers end up wearing.”
So where does this leave small business borrowers?