Why banks won’t lend to SMEs, and what you can do about it


It just keeps getting harder for SMEs to gain funding – but if you’re a business owner, there are great options available to you that you might not have considered. 

Australia is an entrepreneurial nation, and small and medium-sized enterprises (SMEs) are the engine room of our economy and the backbone of our communities. According to the Australian Government Productivity Commission, there are 2.4 million SMEs in Australia, employing more than 7.4 million Australians (roughly two thirds of the entire workforce), and generating more than $700 billion of the economy’s output.

In fact, according to the Australian Bureau of Statistics, an overwhelming 99.8 per cent of Australian businesses are classified as either small (fewer than 20 employees, or less than $10 million revenue) or medium (20-199 employees, over $10 million revenue). 

Given this economic contribution, it’s vital that SMEs are able to readily obtain the finance they need to operate and grow their businesses. 

There are three well-worn paths to funding for SMEs: banks, government funds and grants or private equity. But these can all be frustrating routes for business owners. 

Let’s explore the funding landscape and suggest a solution suitable for 2022.

Banks and SMEs

Banks have historically dominated the Australian lending market, and have been the main source of finance for SMEs. 

Over the past few decades, however, banks have been shifting their focus away from business lending and towards housing loans. According to the Australian Government Productivity Commission, lending to businesses represented 55 per cent of banks’ lending (excluding lending to government) in 1990, but had declined all the way to 32 per cent by 2020. 

In his book Breaking the Banks: What Went Wrong with Australian Banking?, author Joseph Healy – a former senior executive at two of Australia’s largest banks, and now the CEO of SME-focused lender Judo Bank – points out that in the year 2000, for every $1000 Australian banks loaned for a mortgage, they loaned $1000 to small and medium-sized businesses. 

In just under two decades, that ratio was decimated. In 2017, for every $1000 in home lending, the Big Four banks – ANZ, Commonwealth Bank, National Australia Bank and Westpac – loaned merely $130 to SMEs. In other words, the major banks went from lending a dollar to an SME for every dollar they lent for a residential mortgage, to lending just 13 cents to an SME for each of those dollars. 

The banking industry has clearly undergone a realignment. They no longer see their role as small business lenders, but instead as mortgage providers, committed to maximising return on equity. This approach has been shaped by prudential regulation, a legal framework designed to make the banking sector more resilient and safer for depositors by lowering the banks’ supposed risk. 

According to the Productivity Commission’s 2018 inquiry on Competition in the Australian Financial System, prudential regulation has made lending to SMEs less attractive for the major banks, because SME lending is not as profitable as lending for residential property or personal lending. 

When banks do offer finance to SMEs, they tend to require property as collateral, in order to reduce their risk. Loans secured by residential property are now the most prevalent source of finance for SMEs, upping the stakes significantly for business owners and deterring those who don’t have property to use as collateral from applying for finance. 

The Productivity Commission found that SMEs also face higher lending costs than larger firms, and that small businesses pay higher interest rates than larger ones. Onerous loan assessment processes have also been highlighted as a key challenge faced by SMEs in accessing finance. 

The 2021 SME Banking Insights Report, commissioned by Judo Bank and conducted by global banking research and advisory firm East and Partners, found that at least a quarter of SMEs looking for finance to grow their businesses were turned away by the incumbent banks, and that SMEs’ trust in the big banks has fallen to record lows. 

Similarly, the OECD’s Financing SMEs and Entrepreneurs 2020 report found that Australian SMEs are finding it more difficult to access finance through the banking system, and that small-businesses in the start-up or expansion phase without high-quality collateral have particular difficulty accessing finance. 

The question is: Where does this leave Australian small and medium-sized businesses seeking funds? 

Government funding for SMEs

The issue of funding for SMEs became so significant that in 2018, the Federal Government announced the $540 million Australian Business Growth Fund (ABGF). The Government made an investment of $100 million in the fund, and each of the Big Four banks committed $100 million, with HSBC and Macquarie also committing $20 million each. 

The ABGF was formally established in 2020 and made its first investments in 2021. Amongst other things, it was intended to increase the patient equity capital – investment made with no expectation of turning a quick profit – available to SMEs, and to increase the level of investment in SMEs across Australia. 

In theory, this is a great initiative. In practice, the problem is that the ABGF provides equity injections between $5 million and $15 million for each business it invests in, but under its own rules, can only make minority investments (up to 49 per cent). 

You can probably see the issue here. If the ABGF invests a minimum of $5 million, and can only make a minority investment, then the smallest business the ABGF can invest in is one with an enterprise value of $10 million. In fact, the ABGF’s ‘ideal businesses’ generate between $10-100 million in revenue – by definition, this rules out small businesses with less than $10 million revenue, and most medium businesses, making it extremely difficult for them to access the fund that was ostensibly intended to support them.  

The reality is that most businesses generating the amount of revenue sought after by the ABGF already have the ability to raise capital from private equity firms, while smaller businesses continue to be left out in the cold.  

Where can SMEs go for funding? 

While the major banks are increasingly reluctant to lend to SMEs, and the fund intended to benefit SMEs seems designed to assist only the businesses on the larger end of the SME spectrum, there are some positive signs for the SME lending market. 

The incumbent banks’ shift away from the market has led to the arrival of new lenders. The most noteworthy of these is the aforementioned Judo Bank, which made its ASX debut in November 2021, becoming the first bank to list on the Australian Stock Exchange in 30 years. 

A challenger bank that’s purpose-built for small and medium-sized businesses, Judo provide business lending solutions starting at $250,000, and have set themselves the goal of becoming Australia’s most trusted SME business bank. 

To that end, they’ve developed what they call a ‘high-touch, high-tech model’ in which their bankers analyse each business’ opportunities and potential, and arrive at judgement-based lending decisions that aren’t based solely on looking at credit scores, assets or security. 

And while small to medium-sized businesses are often too, well,  small to attract funding from private equity firms, there are exceptions. Enter PieLAB – a financial investor in SMEs that likes to partner with founders and CEOs.

Unlike most private equity firms, PieLAB isn’t looking to simply grow your business and then sell it. Instead, we prefer to buy a significant stake in a business, and then grow and hold it for the long term. 

We seek out businesses with great leaders who want to develop and grow, and we invest in those leaders as much as we invest in their actual business. The people who invest in PieLAB’s funds are owners and operators of businesses themselves, who understand that building an impactful, sustainable and profitable business requires time, patience and resources. 

It also requires people, which is why we encourage the leaders of the businesses we invest in to retain their key staff – because they’re the people who are best-placed to take the business to the next level. 

With PieLAB’s long-term investment focus, the founders and CEOs we work with and their key staff can continue to operate the business the way they’re accustomed to, with the added benefit of additional capital, networks and access to advice and mentoring from PieLAB’s panel of experts

We don’t interfere in the day-to-day operational decisions in a business – that’s up to the leader of their business and their staff – but we do provide a framework to help founders succeed, without the burden of owning and operating a business alone. 

You can learn more about the businesses PieLAB decides to invest in here.  To learn more about how PieLAB can help your business grow, contact the team today.


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