Month: April 2020

When a small business owner in the UK applies for a  $250,000  business loan under their Government supported SME loan scheme the bank cannot ask for a personal guarantee.  Under the Australian scheme the bank cannot request security.  In New Zealand SME borrowers are asked for both security and personal guarantees. So why the differences? This article looks at the three  SME loan support  models to compare the features and specifically looks at personal guarantee requirements.

Here are the three SME Loan schemes

Some may wonder why the UK government do not ask for personal guarantees at all on small loans and only for a restricted guarantee on larger amounts. The reason is explained in my earlier article – Banks Must Lend Beyond Traditional Collateral, which explains the underlying  heavy bank bias to property based lending.  The UK regulators recognise that the only way to get banks away from relying on peoples’ homes as collateral is to specifically prohibit it. The Government is  guaranteeing 80% of the risk so are instructing banks to assess the business on a stand-alone basis for their 20% risk share.  The UK actively encourage asset based lending products under their scheme and non-bank lenders can also participate.

Even the Australian model, which is described as Unsecured, has a strong  bias towards property because of the personal guarantee.  In  New Zealand the anecdotal evidence already is that the Austraian owned banks will only accept SME loan applications under the scheme  from existing bank customers with personal guarantees backed by property.  Will there be reporting of how many customers actually get access to finance without putting their home at risk? 

The New Zealand SME loan guarantee scheme was developed by the Council of Financial Regulators, comprising the Reserve Bank, Financial Markets Authority, the Ministry of Business and Innovation and Treasury. That is representative of all the stakeholders except one, the customers who need the finance. Where is the input from the Small Business Advisory Council and others? SMEs are the driving force of economic growth and face challenges now that are greater than they have ever seen. New ways must be found to help them go forward. Many will still have sound business models and future orders to process but need liquidity desperately.

In my view the banks here and in Australia are not anti SMEs, they have simply failed to develop new ways of lending to them to keep pace with the needs. The simplistic property based focus will not be enough and their blanket catch-all personal guarantees discourage applications.

An Alternative Personal Guarantee Model for New Zealand

It will be very difficult to switch New Zealand into a no guarantee model and the likely  impact would be even less lending. On the other hand SMEs are discouraged from taking risk and investing in their businesses if their home is at risk. 

An alternative model is to have a limited personal guarantee whereby the SME owners are only liable for the debt if there has been fraud or theft of funds from the business. The SMEs must pledge that the finance will be used exclusively for business purposes and that personal drawings will be no higher than in previous periods or as per a business plan. They must disclose truthful information and cannot use the funds unreasonably, such as  buying a new sports car, or get paid excessively, otherwise their conditional guarantee will be enforced.

The personal guarantee, if it is applied,  should also be capped at 20% of the loss, as the UK model allows. The NZ Government already guarantees 80% of the risk under this scheme, while the bank takes 100% of the profit from the loans and has just 20% risk.  Surely under that environment special conditions should apply.

Simon Thompson is an international specialist in Access to Finance for the SME sector. He is an ex banker and finance company CEO and has worked as a Consultant for the World Bank/IFC and Asian Development Bank in over 25 countries since 2006. He is a Director of Lock Finance, a niche NZ invoice financier, and has provided credit and risk management workshops for banks throughout Asia and the Pacific region.

This is a call to banks to accelerate product development work and move immediately into expanded movables-based finance products.

Much has been made of increasing access to credit for the SME business sector as part of Covid19 relief strategies. Governments are even funding schemes themselves, either directly or through traditional banking channels. It sounds great, a positive “hand up” rather than hand-out for the business sector. But is that the reality? Will small businesses really be able to get new funds? Sadly, in many countries, the answer is no.

The problem lies with the standard banking model. Worldwide most banks still use outdated collateral requirements which rely heavily on traditional real property, i.e. the business owner’s home or office building. In the bank SME financing sector it is rare to find other collateral used in a meaningful way. As a consultant for the World Bank and Asian Development Bank for several years, in multiple markets, I have seen this problem first hand. The World Bank data shows that on average 78% of SME business assets are movable assets such as inventory, machinery and receivables while only 22% is land and buildings. But in developing markets about three quarters of all bank loans are secured by property . Fortunately there has been a huge push in recent years by the development banks and others to change this model and introduce improved legal frameworks for movable asset finance. Never has this new model been more needed than now, in a Covid19 world.

Even in my home country of New Zealand, which has one of the best practice Secured Transactions frameworks in the world, the banks are primarily offering new Covid19 loan schemes as an extension of existing credit limits only, where the SMEs already have property mortgaged, and that is despite an 80% Government Guarantee on the new loans! What about adding genuine new credit based on movable assets? Where is Purchase Order Finance – financing stock orders so that businesses can re-stock, or Contract Financing, Inventory Financing, and Accounts Receivable Finance/Factoring? Have banks forgotten how to do these well proven financing products or have they decided the administration and risk management is too hard?

Any change to the old banking model cannot come without a change to risk assessment. Banks have been operating on a remote control points based credit scoring system that relies on the traditional client assessment criteria – 3 years of historical financial data, good payment and credit history plus a weighted value mortgage collateral over land. It is a numbers game, simplified down so that credit decisions are easy. But of course only a few SMEs qualify. Movables-based finance, on the contrary, looks at the business cycle assessment first. The loan repayment comes directly from the sale of the goods being financed, not from some theoretical long term profit projection. The question being asked is, does the client’s business model work, can the assets we are financing be sold within the reasonable timeframe to repay this finance and can I track and control the funds through that cycle? That is not a difficult process if the bank is open to trialling new products and new risk methodology, the type that IFC and ADB have been demonstrating to financiers and for which the legal systems have been strengthened.

Many banks around the world are already developing new products and lending capacity in the movable finance space but it has still been too slow. The old model is hard to move away from when Credit Committees and Boards are familiar with traditional property lending. But right now is the time! This is a call to all banks to accelerate your product development work and move immediately into expanded movable- based finance products.