What do the latest recommendations on the Banking Code of Practice mean for SMEs?

The Australian Banking Association’s Banking Code of Practice is the mainstay of the banking industry’s efforts at self-regulation. It sets out the standards of practice and service customers can expect from their bank. 

The first code was released in 1993 and since then, the ABA appoints an independent party to conduct a review every three years. In 2020, Mike Callaghan, a former senior treasury official, was tasked with conducting the latest review. His report makes 116 recommendations, several of which relate directly to how banks should engage with small business customers.

So what do these recommendations mean for small businesses?

Taking into account future earning capacity 

The review recommends that future earning capacity be taken into account by banks when assessing the capacity of a small business to repay a loan.

Banks will, not unreasonably, say they do this already when they ask for business plans and budgets. The imponderable question is just how much weight in the loan approval process is given to future earning capacity relative to the value of security offered.  

Banks will say these are two separate issues and the decision to lend is based on capacity to repay, while the security is only taken to protect the bank in the event the future cash flows fall short of the numbers on which it based its decision.

Reliance on third-party assurances

The review recommends that while it would still be appropriate for a bank to rely on third parties when assessing capacity to repay a loan, the approval of a loan should not be dependent on a third party (such as the small business’s accountant) certifying the capacity of the small business to repay a loan. 

This seems like an each way bet. Is this just the banks being extra cautious and looking for a potential scapegoat in the event of the borrower getting into financial difficulty?

Not surprisingly, CPA Australia believes banks should not be allowed to request accountants to certify the ability of a business to repay a loan. 

Arguably it is not unreasonable to expect a diligent and prudent banker to be able to make a lending decision without reliance on a third party, which is not a bank.

Approval delays

The review recommends that banks should provide more detail about the loan approval process to small businesses, including if there is a likely to be a delay in deciding on a loan application.

Further, if a bank does require additional information, it should endeavour to ensure this does not delay the bank’s decision.

Decision making lead times have been a nightmare for many small business owners, and a number of banks have openly acknowledged this as a problem.

By the same token, it is not uncommon, and very often more than reasonable, for the bank to ask for additional information to properly and fairly assess a loan application. And sometimes it takes small business owners considerable time to furnish additional information. 

Advise why a loan was declined

The review recommends that banks tell small business owners the reason, if appropriate, as to why a loan was declined, along with what would be needed for the application to be reconsidered.

The review noted the difficulty in introducing this commitment, as it may clash with the tipping-off provisions under the Anti-Money Laundering and Counter Terrorism Financing Act. There may well be cases where this applies but they would be a very tiny minority.

It is important for both the small business owner and the bank that accurate and useful feedback is provided when a loan application has been declined.

Broadening the scope

The review also recommends the reference in the Banking Code to banks providing “lending to small business” be amended to “banking services to small businesses”.

This recognises that small business owners no longer see their bank simply in terms of providing debt or even transactional banking, and that small business owners are finding that it is possible, even beneficial, to have relationships with multiple financial services providers.

It is interesting to observe that Judo Bank, which prides itself on bringing back traditional relationship banking to SMEs, is growing rapidly without having to offer transactional banking services.

What else could the review have recommended?

Anna Bligh, the CEO of the ABA, has welcomed the release of the review and noted its recommendations will be reviewed before the association responds by March 2022.

However, several other suggestions made by the Australian Small Business and Family Enterprise Ombudsman in its submission to the review weren’t included. One that particularly resonates is a suggestion for banks to commit to discharging registrations on the Personal Property Securities Register after the repayment of a loan. 

Knowingly or otherwise, the failure by banks to remove their registrations creates problems for small business owners when accessing new finance. By the time the next code review comes around in three years, more small business owners will unfortunately have been adversely affected.

Similar to this, small business owners are often frustrated with the hoops they have to go through to obtain (and release) bank guarantees. A recent government survey revealed 43% of small business owners suffered because the bank guarantee process took too long.

The review’s recommendations are steps in the right direction, but it must be said that these, as well as existing code clauses, provide banks with ample ‘wriggle room’. This is not unexpected in industry initiated codes of conduct.

The Banking Code does have an independent Banking Code Compliance Committee (BCCC), which is also appointed by the ABA, but the BCCC has little in the way of punitive powers. The review stopped short of recommending the BCCC be given the power to issue fines to its members for non-compliance, noting the potential for this to go beyond its self-regulating design.

Interestingly, at the same time as the Callaghan review was being conducted, the BCCC initiated its own review, which was conducted by Phil Khoury of Cameron Ralph Khoury. This review made 19 recommendations to improve the performance of the BCCC, one of which is that the BCCC be given the power to ‘name and shame’ banks that breach the code.

The BCCC has said that it welcomes the report and is carefully considering its recommendations.

Neil Slonim is the founder of theBankDoctor.org a not-for-profit small business commentator and advocate. He is also a member of the BCCC’s Small Business & Agribusiness Advisory Panel.