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This report presents the findings from a study of bank lending practices to small and medium-sized enterprises (SMEs). It describes these practices and reviews them from an economic efficiency perspective (which the terms of reference define as maximising New Zealand's long-run rate of economic growth).

Lending Practices

Based on interviews conducted with, and information obtained from, seven banks¹ we note the following:

• All of the banks regard the SME sector as an important part of their portfolio. They perceive growth opportunities and consider the market for this sector to be competitive.
• The facilities offered to SME customers are broadly comparable across the banks and, with two main exceptions, the banks look to lend across the whole SME sector.
• In general, the polices, procedures and processes employed by the banks all derive from international practice, but modifications to parent company policies and procedures are effected to suit New Zealand conditions. In our view, New Zealand banks are at, or only slightly behind, offshore counterparts (notably Australia) in terms of their application of best practice technologies.
• New Zealand has yet to utilise credit scoring as a tool for assessing risk in the SME sector to the extent that it is used in other jurisdictions. This may reflect the relative size of the New Zealand market.

Efficiency of Lending Practices

• We find no obvious signs of inefficiency in the market for lending to SMEs:
  • Interest rates charged to SMEs appear to be competitive when assessed alongside charges to larger businesses and compared against international comparisons.
  • There is evidence from research undertaken by a bank and the Ministry of Economic Development indicating that access to finance is not a major issue for this sector.
  • All banks have policies and procedures for assessing risk in cost efficient ways.
• Notwithstanding these points, there are two sectors of the SME market where access to bank lending is an issue. These are start-up SMEs and SMEs that have intellectual property as their main asset. Theory and evidence suggests that bank lending to these types of SMEs is not the most appropriate form of finance. Other forms, including equity or venture capital, are better suited to their needs.
• While we have concluded that there are no obvious signs of inefficiency in the market for lending to SMEs, there are nonetheless several aspects of the market where there is potential for further enhancing the efficiency of the market.
• Specifically, there may be benefits if there was a mechanism for sharing information between them. We understand that this has been attempted in the past, but without success. Further work is needed to understand the reasons why and address any impediments to information sharing.
• There may be benefits to customers if more information on aspects of lending to SMEs was published (as occurs, for example, in Australia and the United Kingdom).
• The banks have suggested a range of initiatives aimed at improving SME access to capital. These options involve various forms of tax incentive, government grant or guarantee. Evidence from overseas suggests that such schemes do not always achieve intended results. More work would need to be undertaken on the design, purpose and evaluation of such initiatives before being in a position to justify their introduction.

¹ The seven banks comprised ANZ Banking Group (New Zealand) Limited, ASB Bank Limited, Bank of New Zealand Limited, The Hong Kong and Shanghai Banking Corporation Limited, The National Bank of New Zealand Limited, TSB Bank Limited, Westpac Banking Corporation.