Transcript of Question & Answer Session Remarks to the Small to Medium Enterprise/Small Business Conference

Well I’ve been asked to kick off with a couple of questions and so my first question, not sure who to ask this to, but I’ll throw it to the panel. How do we address the cycle of inquiries with limited action policy response? Is a policy response really required?

Chris, you’re the Head of Domestic Markets with the RBA, what do you think about that?

I think it’s really interesting. Well there’s a tension because in some ways what we’re seeing is the commoditisation of banking. So you need to get your costs down so you…It’s very much a cookie cutter type approach and if you’ve got regular collateral that’s fine, it works. I’m a bit surprised that we haven’t actually seen more brokers come into that space to say okay there’s a gap between…You might call them the new innovators and what they can…The information that they can provide and the banks who actually want to lend money, on good risks. So one response is look what you should see is actually a competitive response, that someone actually tries to fill that gap, whether it be a broker or accountants and the like. But then there’s also a bigger issue which is, and it comes back to Scott’s point – and it sort of relates to commoditisation – which is how do you fund the new innovators?

There’s a whole bunch of people who’ve made a lot of money through an appreciation in house prices. And that’s great, very good security for banks. But then you’ve got a whole, the new innovators are going to be or tend to be much younger. We had a…we’ve got a business panel, and it was a guy from Go Get. I’m sure he won’t mind me mentioning this, but he said look he runs an operation here, he’s got all these young people who are manning the phones and that. He says they will never actually be able to –the innovators among them – will find it hard to go to a bank and actually borrow some money because it’s too expensive for them to invest in the housing market. So he sort of posed that question, how are we actually going to fund the innovators who actually don’t have a mortgage? Part of the – you have to take a fairly bigger picture view here – which I think what that actually means is there needs to somehow be an intergenerational transfer from those people who’ve benefitted – so the older ones – to the younger innovators. And then you actually start stepping back into the world of superannuation because that’s actually where the assets of the older people are held. So how do you actually get the super funds to actually fund some of the riskier investments? So I think you actually a lot bigger than just the SME sector, it actually involves a lot of the institutional arrangements.

And the other thing I would say, in terms of inquiries and all of that, the sense that we get when we talk to businesses, in some ways the small businesses, they’re not really actually out for a handout here. They actually want government in some ways to get out of the way, so that they can actually do what they want to do. And from the Bank’s point of view that actually sort of makes sense. Because the way – we’re necessarily looking at aggregates. But what we think is a really good thing for an economy to be, is actually flexible, so that as the price signals change, say the exchange rate goes up – a tough environment for the exporters and the import competers – the resources in the economy can move fairly seamlessly from that area to another area.

Question about the risk weighting of small business loans.

I’d like to find someone from APRA actually to talk about that. But I guess, it was interesting with David Murray’s financial system inquiry because he actually said look basically the capital requirements are not affecting the supply of lending or the relative price beyond the inherent riskiness of a loan. So if you look at…

I think he said he actually had no evidence to prove that.

But this was a perfect opportunity if someone was going to present that. And the thing…I’m going to sound like an apologist for a bank here, but in some ways if you look at non-performing loans to households via mortgages, and that currently is about 0.7 per cent of total loans. During the GFC that just got up to just under 1 per cent. If you look at non-performing loans of unincorporated businesses, it’s currently 1.4 per cent, during the GFC that got up to 3.7 per cent. So it is true that those loans are actually a lot riskier. And so the probability of default is actually higher in a small business, and it sort of makes sense, cash flows are uncertain and all that. And the other thing is that the loss given default is also higher. So the losses associated with a small business loan that’s secured by a residential mortgage I think, on average, it’s about 30 per cent, the losses associated with a residential mortgage are actually 20 per cent.

Chris if I can ask you a question, just to bring the sort of conversation back to what are the new opportunities for SME finance. From the Reserve Bank’s point of view, if you were to provide a recommendation to Federal Government about what opportunities you would or what the Reserve Bank would want to look at, what would those opportunities be?

In some ways we’d be quite reluctant to point to a specific thing and in some ways that reflects our mandate to be honest. We’ve got a very blunt instrument here which is the level of interest rates. But why we actually are really interested in this area is because there’s such a – small and medium size enterprises are such an important part of the transmission mechanism from the interest rate setting through to broader economic activity. We all know the statistics. They account for just under half the employment in the economy, a third of value added. And the thing for me that’s been so enlightening engaging with Scott and Michael and all of these, is actually understanding that you can’t really think of the SME sector like you think about large corporations. They have this very big administrative managerial function, so they’ve outsourced that to a group within an organisation. For SMEs it’s all a mixture of a household and a business decision. And then within that you’ve probably got these groups which – some really want to grow, some are actually, I think it’s a very large share, actually don’t have employees, so they’re your tradies and the like, and then others who actually only want to stay at a certain point, and that might reflect because payroll tax cuts in. So it’s a really diverse sort of sector and we actually need to understand how they respond to interest rate signals and the like.

And what we…one of the ways we do it, it’s only a small thing, is we run a small business panel. It’s been running for 21 years or so. And to be honest it’s the most refreshing meeting I ever attend each year. The Governor comes along and all of that and it’s actually small business people. There’s a bit of a bias in the selection, in as much as they tend to be winners of Telstra business awards and the like. But just listen to them! It’s about – well we’ve had Seek, the guys from Seek when they were a small business, and Go Get. But it’s just refreshing, they just want to do what they do.

Finance comes up. Because one of the reasons that we actually convened this group was we talk to banks a lot. And so you’ll get a message from them. But we actually wanted to hear from the people who were actually looking for finance and the like. And as I said earlier, it was the Go Get guys that said actually I think we’ve got a bit of an issue here in terms of funding the young innovators, and we’ve got a system that’s very much focussed on mortgages. So that’s fine right now but if you look ahead is that actually going to sustain that financing of innovation? This has then made us look at what do other countries actually do. And that’s what was interesting. I think Germany, for example, seems to be able to fund the middle-sized enterprises very effectively and I think it does go to equity.

Sorry we’ve got a question down the back here.

Scott I’ve got an observation from your planning said that more than 50 per cent of applications are rejected. That’s a big number. If I think of the bank, although I’m not a banker, out of that 50 per cent even – out of 50 per cent eligible and some of them don’t know how to prepare the application or they didn’t put the documents properly, there’s a big loss. I mean these people cannot grow one, they cannot borrow or they knock on the doors of private lenders and they pay high cost on what they have, so it’s a big loss to the economy as such. Do you think there’s something…The RBA has to have a special place or a special arm basically to look after the innovators …? Most of the emerging countries they do have a dedicated Board or dedicated banks basically coming to central banks to look after the needs of these SMEs. There’s a need to educate these people. We, as academics, are happy to do that. But there’s a big cost to that of people not getting loans. Banks are sitting with heaps of cash. It’s not that they should give out freebies, but they want…Chris?

Well in some ways, which is the challenge I think with Scott’s idea about innovation, is how do you actually pick the innovators? It’s not clear to me how you do, do that. And if you’re going to pick winners in some ways we’re talking about a subsidy. And that’s actually better done through the fiscal side of things, not through some hidden central bank cheap funding. I mean you want transparency, you want accountability, if you’re going to move resources effectively, the fiscal resources of the Government.

So tax incentives?

So all of that stuff should be done through the fiscal accounts, not through some back door way of using the central bank, to be honest.

I have a question for Chris. Should we encourage or allow foreign venture capitalists to enter the Australian market and provide funding to the new innovators or the start-ups?

Well capital…

How do you do that?

… well capital flows very freely into Australia. As I understand it, there aren’t actually restrictions, well as best I can tell.