Inevitable, but destructive: The fallout from the banking royal commission is hurting small business

Everyone agrees. The financial services royal commission was the inquiry we had to have ⁠— the malevolent behaviour of the major financial institutions over many years made it politically inevitable. 

But make no mistake. Although the recommendations flowing from Kenneth Hayne’s inquiry will help clean up the financial services industry, there is an economic downside that’s becoming more evident by the day. 

The simple fact is the royal commission is constraining the economy in ways no-one dreamed of when the Turnbull government bowed to the inevitable and announced the royal commission on November 30 2017. Like a deep-sea trawler, it’s not discriminating. The innocent are being snared with the guilty, with all the evidence suggesting the former far outweigh the latter. Its little wonder Treasurer Josh Frydenberg wants the recommendations emanating from the royal commission to be legislated as soon as possible.

From the vantage point of boutique mergers and acquisitions, I am seeing individuals struggle to get a mortgage, business owners trying to start a new business being tied up in red tape, and larger businesses not able to access debt to grow. The net result is a less competitive Australian business environment where the only companies readily obtaining finance are the behemoths. 

Here are a few examples.

• A new company we advised was finally established in July. It took three weeks, yes, that’s right, three weeks, to open a bank account with one of the ‘big four’ banks, and another two weeks to open a direct debit facility. The paperwork and questions involved would have confused an economics professor.
• A financial services firm operating for seven years with an unblemished track record received its annual professional indemnity insurance quote — a 54% increase compared with the previous year. The reason provided by the insurance broker, in two words: “royal commission”. In addition, the company received a new $3,000 ASIC fee for “monitoring”, and its auditor’s annual fee has increased by 20%. The net result of these changes was a 30% reduction in profit. Now the owners are questioning whether they should even continue with the business — surely not the outcome anyone wanted.
• A married couple, double income no kids (DINKS), received a loan approval at a 70% loan-to-value ratio (LVR) in early-2018. Despite increases in their pay, in 2019 their mortgage application was subsequently denied because one person in the relationship started a private company to generate extra income on weekends. 
• A large company employing more than 100 people wanted to buy a smaller competitor. Despite the acquisition being accretive, it’s ‘big four’ bank was “uncomfortable” with gearing exceeding one year of EBITDA (earnings before interest, taxes, depreciation, and amortisation). The same bank was comfortable with three times EBITDA less than 18 months ago for transactions in this industry. The bankers on the deal were not only scared to lend, but they also had no incentive to lend because there are no longer bonuses for excellent performance. After three months of negotiations between the bank and company, both parties agreed to a new capital structure. It then took another two months to finalise the paperwork.
• An IT services company that had 40 employees and generates $2 million in annual profit wanted a $1 million loan to invest in new systems and staff. The company, being in the IT industry, has no fixed assets. Three banks rejected their application for the loan on the basis that “the company has no assets to provide as security”.

Credit is drying up, loan conditions are becoming more stringent and the banks’ historical obsession with fixed assets (namely property) as security still prevails. At the same time, we are seeing many new businesses emerging in the digital age where they don’t have (and never will have) fixed assets. The Reserve Bank can cut interest rates to zero, but it isn’t going to make any difference if credit remains elusive. 

Frydenberg recently urged businesses to invest. I suspect 99% of business owners and chief executives would like nothing more than to do this. But red tape, a credit squeeze that’s assuming python-like qualities, and nervy investors are stifling investment and innovation. And I suspect things will only get worse as Canberra responds to the royal commission with more and more legislation. It might save some consumer angst and earn some political kudos — but at what cost to the broader economy?

What all this tells me is that businesses, especially small businesses, need to both plan and build relationships, especially with the finance community. Developing these relationships now could save businesses a lot of angst in the future. 

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