Is small business losing out on interest rates?
By Steven Münchenberg, Chief Executive, Australian Bankers’ Association
28 February, 2013: 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.
In raising their concerns, small businesses point to the difference between the interest rate charged for a home loan and the rates charged for a small business loan, even when secured against a residential property. 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.
Lending experience shows, however, that the two types of loan do not perform the same. The consequences if a loan goes bad are also different.
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, for December 2011, show business loans that were 90 days or more behind in their repayments accounted for around 4% of loans. By way of comparison, home loans at the time had a 90+ day arrears figure of 0.7%, less than a fifth of the rate for business loans. So business loans are significantly more likely to get into trouble.
Banks also know that when a loan goes bad, they recover less of the debt from business borrowers than from households. That is, 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 increases the risk of the loan and banks set interest rates, in part, according to risk. The riskier the loan, the higher the price.
The biggest effect of this was seen when banks increased the interest rates on business loans as the global financial crisis (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.
But the higher risk of small business loans has another implication. The Australian Prudential Regulation Authority (APRA), the banks’ prudential regulator, 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? They do pay more than home borrowers, because they are riskier, but how much more?
The latest figures from the Reserve Bank show the average advertised rate on a small business residential secured loan is 7.60%. This compares with the average advertised standard variable rate for a home loan of 6.45%. Today’s risk premium for small business is therefore, on average, 1.15%.
This is higher than before the GFC. Over the three years leading up to the crisis, the small business residential secured loan rate averaged 7.73%. For a home loan, it was 7.50%. In other words, the gap has grown from 0.23% to 1.15%, an increase of 0.92%. This increase was not a gradual change, it all happened over two months in late 2008, at the height of the GFC.
The gap between home and business loans has grown with the change in capital rules and risk re-pricing, reflecting the reality that small business lending is riskier than home loan lending, even when small business owners puts their houses on the line.
Small businesses do pay more than home borrowers for their credit, but not because the media and politicians have neglected them. Basically, lending to small businesses is riskier, so small businesses pay more.