5. Opportunities for Further Enhancing Market Efficiency
The efficiency with which banks collect and process information lies at the heart of their role as financial intermediaries. Accordingly, discussions with the banks have included a focus on options for improving the level and quality of information available to the banks in the context of lending to SMEs.
In addition, some comments are made regarding process improvements that are being implemented by the banks. Finally, we briefly consider several other initiatives that the banks have suggested could be considered with the objective of improving SME access to capital.
Information
Two issues in relation to information sharing have arisen during the course of this study. The first is that there is minimal sharing of information between the banks. The second is that there is little data published in relation to SME lending.
Information Sharing
Several of the banks noted during the interviews that attempts have been made in the past to centrally collate and disseminate information which the banks hold in relation to lending to their SME customers. The point was also made, however, that in general, one or more banks have usually pulled out of such initiatives. Because this undermines the usefulness of the information, initiatives to share information have not been successfully implemented.
We are aware that ACNeilson prepare a Small Business Banking Monitor. We understand that several, but not all of, the banks covered by this survey subscribe to the Monitor. However, the Monitor draws on surveys of SMEs. Accordingly, it does not include all information that would be of interest to banks including, in particular, information that is useful for risk grading purposes.
We consider there are some parallels with the insurance industry in terms of the desirability of having pooled data. Within the insurance industry, pooling of claims data is relatively commonplace (e.g. in the health, accident, life and fire/general sectors). Data is pooled either by insurance companies, or industry associations or commercial third parties for re-sale to insurers and others. The drivers for collection can be both commercial and regulatory in nature.
We note also the roles of the Australian Prudential Regulation Authority one of which is the collection and collation of statistics across a wide range of financial institutions including banks as part of the organisation's prudential supervision role.
Each of the banks indicated that they would be willing to provide information on lending to the SME sector to a central repository for aggregation and distribution provided that commercially sensitive information was protected. However, none of the banks offered views as to how information sharing might be achieved.
The impending implementation of Basel II provides an opportunity to progress this issue since it is focussing attention on the drivers of risk. The development of credit scoring is a further and complementary driver in this regard.
If pooling of data collection is to become a reality, however, there may be a need to develop some standards to govern the type of information collected. As noted earlier in the report, different banks apply different definitions to SMEs, collect different types of information in relation to SMEs and use different systems for the collection and management of data.
Common standards will potentially enhance the usefulness of pooled information. From the banks' perspective, there will be a benefit cost analysis to be undertaken to weigh the advantages of pooled data against the costs of collecting data. Given the difficulty we have had in gathering comparable information for the purposes of this study, there may be a considerable amount of work required by the banks to produce comparable data. The fact that the banks have unsuccessfully tried to collectively pool their information suggests that some form of incentive may be required in order to make progress.
Information Publication
There is limited data is published in New Zealand in relation to SME lending. The table below summarises information relating to SME lending which is published on a regular basis in Australia and England by each country's central bank.
In addition to the above, the British Bankers Association web-site provides comparisons of the range of facilities offered by a large number of banks to SMEs. The web-site provides details of bank fees but it does not extend to comparisons of interest rates.
Potentially, there is scope for the Reserve Bank and the New Zealand Bankers Association to consider publishing similar information to that described in the table above. As with the data sharing issue, however, there is a benefit cost issue to consider particularly in light of the current non-standardised nature of data currently held across the banks.
Publication of data relating to facilities on offer, margins, security requirements and so on would be of benefit not only to the banks themselves but also to customers. In general, the better informed are customers, the better placed they will be to make choices between competing service offerings.
Quality of Information
The banks have indicated that the quality of information received from SMEs in support of loan applications is highly variable.
We discussed with the banks their impressions of the extent to which SME clients sought external advice from government-sponsored and other advisers. The response indicates that use of professional advisers is mixed.
With respect to government-sponsored agencies such as "biz-info", the banks indicated that their impression was that SMEs were generally aware of such agencies. However, some quite strong themes can through from the banks in terms of a perception that SMEs were not always sure how to access the services on offer and/or were somewhat confused by, or did not understand, the array of services on offer.
In the light of this, some banks suggested that one way of improving the efficiency of lending to SMEs would be to further increase government (central or local) support for government-sponsored advisory agencies and/or improve the "signposting" for such agencies so that customers have a better understanding of what is on offer.
The comments made suggest that there may be an underlying policy issue in terms of how best to strike an appropriate balance between providing a standard package of business support which is easier to publicise and access versus providing a service which caters to a range of specialist and local needs.
In light of the comments made by the bank, we conclude that there may be scope to undertake further work to identify whether there are issues in relation to the co-ordination of, and access to, government sponsored business support agencies.
Process Improvements
Application and Behavioural Scoring
As discussed in Appendix B, the banks are developing credit scoring techniques with a view to application to the SME market. The focus is on reducing manual processes that are both time consuming and expensive to operate.
This involves developments in terms of application scoring (i.e. the process of credit scoring that takes place at the time of loan application) and behavioural scoring which is a form of credit scoring which looks principally at the behaviours of the customer as distinct from the financial factors used in determining accept/reject loan decisions.
Process Re-Engineering
We understand that the banks continually focus on initiatives to improve the efficiency of loan application processing and management. Consistent with developments in relation to scoring, the objective is to reduce the time and cost involved in approving, managing and reviewing SME loans while, at the same time, not compromising the level of quality of information necessary for decision making.
The banks are making increased use of technologies such as XBRL. This is an internationally agreed taxonomy of accounting terms, which is used to establish a standardised chart of accounts in electronic form. XBRL enables the banks to, for example, electronically extract from business customer financial accounts those financial details that are relevant and convert them into the normal format for bank analysis.
Further, the banks increasingly attempt to find cost effective ways of obtaining information from SME customers as part of normal day-to-day customer interactions with the banks.
The progressive take-up of internet, email and telephone banking has also improved the efficiency of services provided to customers.
Based on our knowledge of bank practices in New Zealand and offshore (particularly Australia), our judgement is that New Zealand banks are largely comparable with, or only slightly behind, their parent banks in terms of their development maturity and application of best-practice technologies. Australian banks are fairly well aligned with international best practice although there are some exceptions most notably in relation to credit scoring where the US market has a longer history of using this tool.
Brokers
Some of the banks noted that they obtain customers through brokers. While quantitative data was not available, in general the impression is that this channel accounts for a small proportion of total customers. The comment was made, however, that in the United States, brokers are becoming a larger source of referrals.
There are benefits and costs associated with the use of brokers. One potential advantage is that brokers can provide a screening process for the banks and, in this regard, can assist in dealing with information asymmetries.
However, using brokers introduces another layer of cost into the overall lending transaction. These costs have to be recovered from somewhere. To the extent that competition has already pushed margins to low levels, the use of brokers could imply an increase in lending costs.
It is likely that brokers may be better suited to some parts of the SME market than others. For example, brokers are used in the residential mortgage market. Given the prevalence of SME lending that is backed by residential properties, it is likely that brokers are, by implication, already a feature of a part of the SME lending market. Brokers are more likely to be cost effective where the lending product provided is highly standardised and competition is purely price-based. Equally, brokers are likely to be less cost effective where the nature of the product/service offered is more bespoke in nature. In this context, the banks have noted that the circumstances surrounding individual SME customers varies widely and there are dangers in attempting to "pigeon-hole" them into well-defined categories.
Other Initiatives
The banks suggested a number of other initiatives aimed at further improving SME access to capital. To varying extents, all of the options involve government intervention by way of tax incentive, grant or guarantee. The principal options raised were:
- Further development of venture capital funds with an implicit assumption that this would involve some form of financial backing from the Government
- Government guarantee or underwriting of SME loans
- Government provision of export guarantees.
As discussed in section 4 of this report, to the extent that there is any evidence that the banks are unwilling to provide finance to SMEs on competitive terms, the "market failure" this implies is limited to start-up SMEs and SMEs where the primary asset is intellectual property.
It is important to note, however, that even if there is a degree of market failure, it does not automatically follow that the Government should intervene since intervention of itself involves both costs and benefits. These have to be compared against the costs associated with the perceived market failure.
It is beyond the scope of this study to undertake an analysis of the various initiatives raised by the banks. However, a few comments can be made based on similar initiatives operating elsewhere. In particular, we have drawn on summary analysis provided by the Bank of England in relation to a range of schemes operating in the United Kingdom which, in theory, are targeted at start-up and IP-based SMEs.39
Specifically, in relation to venture capital, the Bank of England has commented on two schemes - Venture Capital Trusts (VCT) and the Enterprise Investment Scheme (EIS). Both schemes involved tax relief for investments and relief from capital gains tax (which obviously is of less relevance in New Zealand). The terms of the schemes have meant, however, that they are not well targeted at small businesses. As a result the VCT has failed to raise as much money as was targeted and only one-in-five investments have been in start-up SMEs. The EIS similarly is not well targeted at small companies.40
With respect to underwriting or guarantees for SME loans, three schemes operating in the UK have some relevance:
- The Small Firms Loan Guarantee Scheme (SFLGS). This involves provision of a government guarantee to lenders.
- The Small Firms Merit Award for Research and Technology (SMART). This involves providing grants to SMEs to assist them in accessing technology and research with the objective of developing innovative products and processes (in other words, to held SMEs get started)
- The Enterprise Fund. This Fund aims to assist SMEs in gaining access to finance through two channels. The first channel is an equity fund comprising private and public sector contributions and the second channel is through loan guarantees (in this respect, the Fund has absorbed the SFLGS).
None of the schemes appear to have met with overwhelming success in terms of improving access to capital. The SFLGS has had limited effect in stimulating finance for IP-based SMEs with less than 10% of the total number of loans being made to IP-based SMEs.41 The implication appears to be that the overwhelming majority of loans are made to other forms of SME where the case for some form of Government assistance is, or might be, less strong. The Enterprise Fund has absorbed the SFLGS. We are not aware of any research undertaken to evaluate the effectiveness of the fund. This may reflect the relatively short time that the Fund has been operating (approximately 3 years).
The SMART scheme has had relatively better results compared to the SFLGS although the evidence remains somewhat mixed. One evaluation of the scheme concluded that that there was little evidence that the scheme had made much difference to the attitude of venture capitalist to investment in small high-tech firms. Another study, however, concluded that the injection of finance to fund innovation assisted the long-term prospects of the SMEs involved and established a degree of track record. This in turn has improved the chances of these SMEs obtaining bank finance.42
Implications for New Zealand
The observations noted above do not necessarily give good guidance to the impact that such schemes might have in New Zealand. However, there are three conclusions that can be drawn.
Firstly, there needs to be clear problem definition. It is not a foregone conclusion that Government assistance will actually result in achieving the objective of improving access by start-up and IP-based SMEs to capital (bank finance or other). Second, the choice of instrument to address the problem needs to be carefully evaluated. The design of any scheme is likely to be critical in terms of its chances of success. Thirdly, there needs to be a clear basis for monitoring the effectiveness of any initiative that is implemented.
These conclusions suggest that much more work would need to be undertaken before being in a position to justify further government intervention to address perceived failure, if any, in the market for lending to SMEs.
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