On 26 November 2021, Mike Callaghan AM PSM handed down the final report into the 2021 independent review of the Australian Banking Association’s (ABA) Banking Code of Practice (the Code). The review made nine recommendations concerning lending practices to small businesses. While the report noted that the Code provides small businesses with ‘significant protections that go beyond that available in the law’,^[1] it also critiqued that the Code’s failure to distinguish between the needs of small businesses and the needs of individuals ‘adds to perception that banks do not understand small business’.^[2]

Overall, we consider that small business will benefit from greater certainty on the Code’s application to small businesses and responsible lending requirements. Broadening the definition of ‘small business’ will be a win for many Australian businesses as they come under the protections of the Code. Before the ABA comes to a position on the review report’s recommendations, banks may use this time to evaluate how the recommendations will impact their policies, service delivery processes and competitiveness in the market. Implementation will be costly. Accordingly, if the recommendations are adopted, small business should expect banks to consider passing on these costs to borrowers. The pay-off for obtaining greater certainty and protections for small businesses may also involve increased time to obtain credit as well as additional obligations for provision of information both pre-and post-establishment of a loan.

Clarity of application

Reflecting on feedback from consultations that small business is an ‘afterthought’ in the Code, the review report noted that the application of the Code to small businesses only extends to bank lending to small business. This limited application is contextualised by the fact that the Code is predominantly focused on individuals. Accordingly, the review report recommends that:

• Part 6 of the Code should be extended from referring to ‘lending to small business’ to cover ‘providing banking services to small business’; and
• the first commitment of Part 6 should be for banks to assist small businesses with their banking services that are suitable to their circumstances (Recommendation 64).

Definition of small business

The ABA has previously accepted a change to the definition of ‘small business’ as recommended in the October 2020 Pottinger Review – raising the credit threshold from $3 million to $5 million. However, implementing this definitional change in the Code may take as long as January 2023 due to additional reviews and approval required from the Australian Securities and Investments Commission. The review report recommends that this delay should not stop ABA banks from introducing the changes in the definition of small business as soon as they can (Recommendation 65).

By raising the credit threshold to $5 million, more Australian businesses will come under the protections of the Code (the ABA predicts an additional 10,000 businesses^[3]). In turn, banks may begin analysing how the impending extended coverage of small business loans will impact service delivery and competitiveness with other lenders. Australian businesses about to come under the protection of the Code should start taking notice of the Banks that decide to make an early adoption of the revised definition of small business.

Responsible lending

The review report noted feedback from stakeholders that lenders do not consistently draw an accurate distinction between personal lending and small business lending. The former triggers coverage under the National Consumer Credit Protection Act 2009 (Cth), the latter does not. We note that this distinction can often be difficult to clearly identify, particularly when the financial affairs of a small business and its owner are intermingled.

Additionally, the review report accepted concerns raised by CPA Australia that there is a growing trend that banks are requesting a ‘capacity to repay certificate’ from accountants acting for small businesses. The review report considered that relying on a third-party certification of the capacity of a small business to repay a loan would ‘not appear to be in line with the care and skill of a prudent banker’, and that ‘the bank should make that assessment’.

Accordingly, the review report recommends:

• to help clarify what parts of the Code apply to small business, and to recognise there is a difference in the requirements for lending to small business and lending to individuals, the references to small business lending in Part 5 should be shifted to Part 6 of the Code (Recommendation 66).
• the Code should specify that future earning capacity is taken into account when assessing a small business’s capacity to repay a loan (Recommendation 67); and
• the Code should clarify that a bank’s approval of a small business loan will not be dependent on a third party (such as the small business’s accountant) certifying the capacity of the small business to repay the loan (Recommendation 68).

If these recommendations are adopted by the ABA, then there could be more onus on small business to produce evidence of their future earning capacity to repay their loan. However, this onus could be offset by the Code’s rescission of the requirement for small businesses to provide third party certification; which in turn may place higher administrative costs on banks as they make their own certification arrangements. Small businesses should prepare for the likelihood that credit may be harder to obtain in these circumstances.

Loan applications

The review report considered stakeholder views on the loan application process regarding the time it takes banks to decide on loan applications, and the extent of advice banks provide small business if they decide not to approve a loan.

CPA Australia submitted that the Code should have strict time limits for lenders to make a decision on a small business loan application. The review report rejected this submission. Rather, the review report recommends that banks should:

• advise a small business if there is likely to be a delay in the initial indication of how long it would take for a decision, the reason for the delay, and give a revised estimate when a decision is likely (Recommendation 69); and
• commit that if they require additional information when considering a loan application, they will endeavour to ensure that this does not delay the time it will take for the bank to make a decision (Recommendation 70).

The review report also rejected the Small Business and Family Enterprise Ombudsman’s proposal that if a bank decides not to make a loan to a small business, it will clearly advise the business of the reason. However, the review report acknowledged stakeholder concerns that banks are currently permitted to provide ‘generic’ reasons why loans are not approved. In finding a middle-ground, the review report recommends that banks should commit to tell small business the reason, if appropriate, as to why a loan was declined, along with what would be needed for the application to be reconsidered (Recommendation 71).

If these recommendation are adopted by the ABA, small businesses will enjoy a greater degree of certainty throughout the loan application process. But certainty invariably comes at a cost. Banks may increase fees to offset their own costs of updating and expanding their loan application processes to facilitate the provision of information if an application is delayed or a loan has been rejected. Small businesses should keep these fees at the front of their mind. The best deals will likely come from the banks that find innovative solutions to streamline their loan application processes to lower their administrative costs.

Next steps

On 3 December 2021, the ABA welcomed the release of the review’s final report.^[4] Although small businesses were not mentioned, the ABA stated that it will ‘review in detail the recommendations before responding’. We will provide another update once the ABA has confirmed their position on the review report’s recommendations.

^{[1] Final Report, p 113}

^{[2] Final Report, p 119}

^{[3] https://www.ausbanking.org.au/...}

^{[4] https://www.ausbanking.org.au/...}