Bridging Australia's Capital Gap with Microcredit

James Evans, First Business Finance, Australia

Microcredit, or small loans to very small businesses, has received widespread international attention in the past ten years. Many governments see microlending as a cost effective way of building an "enterprise culture", enhancing domestic economic capacity, and reducing both unemployment and transfer payments. The World Bank has issued numerous papers on the subject, and set minimum standards of reporting from microcredit institutions. In Australia commercial microcredit initiatives have been few and far between, and none have received mainstream political or financial support.

A recent NSW initiative, First Business Finance, may soon change this.

The Capital Gap

The boxing match over whether or not there is a "capital gap" for small business has been fought over decades.

In one corner, there are the consumer pressure groups and their academic allies claiming that banks and governments are not sympathetic to the needs of small business, they are too risk averse and that this acts against the future prosperity of Australia.

In the other corner are the financiers and their supporters claiming that the high access costs and risks attached to the small business market make it unprofitable; that there is no market inefficiency and therefore no capital gap.

Wherever the truth lies, there is little doubt that community perception is against the banks, and supports the proponents of more liberal lending criteria.

This paper explains how, in part, the community's expectations can be met.

Defining The Microbusiness

The term Small and Medium Enterprise (SME) can be misleading when describing the small business sector. It appears useful to policy makers and small business interests for two reasons. First it is an internationally acceptable acronym and, second, it is broad enough to encompass most businesses on which current public debate rests; those existing enterprises with the capacity to grow and "emerge" into export markets.

The concerns of the community are perhaps are forged by different, and often overlooked, demographics. The Australian Bureau of Statistics reports that only 9% of Australian businesses employ ten people or more, and over half of private sector businesses employ no-one. When one considers that the definition of an SME includes firms which employ up to 100 people in the manufacturing sector, there is a strong argument for a redefinition, or at least a subdivision, of what constitutes a small business.

This is particularly true given that all the new jobs created in Australia between 1991 and 1993 were attributable to SMEs, and many of these were in very small, or micro-, businesses.

While microcredit is not an accepted term in Australian public policy, its parent, "microbusiness", has in recent years begun to be used. The Coalition's pre-election "New Deal For Small Business" acknowledges the contribution of the very small business and has promised a "Micro Business Consultative Group" to look at ways in which this sector can be fostered.

The most common international definition of microbusinesses - those employing 5 people or less - would include over three quarters of Australia's private sector, or in excess of 630,000 firms. Within this "microbusiness sector" it is the new starters, and businesses in early growth that experience most difficulty accessing finance.

Why Is There A Capital Gap?

There is little dispute about the most common reasons for the difficulties that very small, often young, businesses have finding suitable debt finance:

This last point will not surprise anyone familiar with banks. The transaction costs of a $5,000 commercial loan are similar to those for a $500,000 loan. On standard commercial lending criteria, the client's market assumptions and financial projections have to satisfy similar prudential standards in each case.

Closing The Gap - Microcredit

Microcredit has international currency. European and North American countries regularly use the term, both in government policy formulation, and in their approach to lending. It is also successfully established in developing countries, most notably in Bangladesh where last year the Grameen Bank alone lent US$380 million; average loan size $100, and a repayment rate in excess of 98%.

There have been examples of microcredit schemes in communities around Australia. Small credit unions, revolving community loan funds and similar mechanisms have come and gone over the years. Indeed, the creation of the first Australian Credit Unions fifty years ago were in part a response to the needs of "modest farmers and small business folk".

So far there has been one over-riding problem with these commercial microcredit initiatives. They have been local and small. In an informal survey of twenty microcredit providers around Australia in 1994, the author found that not one had disbursed more than five business loans in the previous year.

Greater volume has been provided by government initiatives, ranging from loan guarantee schemes to straight-out grants. However, until recently there appears never to have been a commercial approach to the market, which can be assessed on commercial terms.

First Business Finance - A Commercial Approach to Microcredit

At the end of 1994, the Sydney based First Business Finance (FBF) embarked on a State Government sponsored pilot program to lend to microbusinesses in a large enough volume to be properly assessed. In its first eighteen months $550,000 was lent to sixty seven businesses. The businesses were either new starters, or in early growth, and ranged from small scale manufacturers and tradespeople, to health practitioners and information/technology specialists. In April 1996 it extended its pilot to the Hunter region of NSW on the back of its early success.

FBF contracts with credit providers to supply applicants who have a profile acceptable to their credit managers. It sources the applicants through community business assistance organisations, particularly NSW's Business Enterprise Centres. Its first contracted lenders have been the Sydney Credit Union and, in the new Hunter pilot, Endeavour Credit Union.

Underlying Principles

There are a number of underlying principles which help to understand how FBF is narrowing the credit gap.

Firstly, it believes that finance alone never determines business success. What makes or breaks a business are the skills and attitude of the owner, and the viability of the forward plan. Most applicants have therefore been trained in small business management and planning skills, and all have a written business plan which has been assessed by a professional in the community prior to approaching the company.

Secondly, that in the absence of adequate owner's equity, the level of debt should be manageable. In other words applicants with few assets and a low level of savings should not be overstretched by the level of debt finance. Repayments should be able to be made whether or not the business meets its projected targets. The maximum loan is therefore $10,000, and it is repayable over five years with no penalties for early repayments. This is an attempt to make this form of debt finance as close to equity as possible - "debtquity" if you like.

Thirdly, while FBF is taking a commercial approach to this market, this is not commercial lending in the traditional sense. The loans are best described as personal lending for business purposes. Loans are to individuals, not companies. In the absence of business track record, and in addition to the business plan, a personal credit record is essential. Residential and work history, as well as a credit reference check, are critical to the lending decision.

Finally, overall FBF is doing something deceptively simple.

By sourcing the clients in community networks, and delivering them with completed applications for credit, it is reducing the transaction costs for the credit provider to the point where there are no marketing or administrative expenses prior to the credit decision. This provides an extra buffer against any extraordinary losses which may occur in the portfolio. In some cases FBF will also offer a guarantee to the institution should it think that the estimated net losses will exceed the breakeven point for profitability on the portfolio.


FBF's first eighteen months has laid the foundations for a venture which has the capacity to narrow the gap between community expectations and commercial reality in small business lending. Its side-affects - sustainable jobs and increased economic capacity - are obtainable without any government money being lent.

The amount lent in the pilot, half a million dollars, is modest in the credit industry's terms. However in the context of the NSW pilot, Sydney Credit Union has provided seed and early growth finance to over sixty businesses, some of whom will graduate from the ground floor to mezzanine finance and higher. Not one of these loans has been secured by "bricks and mortar".

That this lending will help stimulate sustainable jobs is already in evidence. Many of the borrowers are graduates from the New Enterprise Incentive Scheme, a Federal Government training and support program assisting unemployed people to start their own businesses. It claims its clients have an 82% success rate after two years, and for every ten businesses started, eight additional new jobs are created.

The goal of FBF remains to facilitate a high enough volume of credit to prove the viability of this market. At present its strategy - to establish a large enough infrastructure to prove the point - still requires subsidy. The source of this subsidy - the NSW government - confines its operation to the Sydney and Hunter regions of NSW.

A broader reach than this is essential in order to gain the required volume. The only way of achieving this is on a national scale.

Contact adress

James Evans
Managing Director
First Business Finance Pty Limited
May 1996
Tel: 61 2 331 1565
Fax: 61 2 380 6224

Hari Srinivas -
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