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BFCSA: Alarm banking royal commission fallout will push borrowers into shadow banking

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Alarm banking royal commission fallout will push borrowers into shadow banking

Australian Financial Review May 25 2018 11:00 PM

Jacob Greber, James Eyers




Concerns are growing the bank royal commission could crimp bank profits and lending, pushing small business borrowers to the new high tech finance sector, where some are charging more than 40 per cent interest rates.

Moody's has issued a warning the Hayne inquiry could result in tougher regulation, which could slow economic growth by reducing the availability of credit. It described the credit implications of the commission as "negative" for the major banks.

"The increased focus on bank lending practices could lead to a tightening of mortgage underwriting which could weaken credit growth and profitability," said Daniel Yu, a senior analyst at the agency.

Their caution highlights broader risks thrown up by the Hayne inquiry, which may recommend tougher regulation to shield customers from dodgy financial services practices.

But this may have the perverse effect of pushing more financial activity into a new, technology-fueled shadow banking sector, where start-ups are offering quick credit approvals for unsecured loans at eye-popping rates.

Among the upstarts is Prospa, which will list on the Australian Securities Exchange early next month at a market capitalisation of more than half a billion dollars. Its prospectus says its annual average interest rate is 41 per cent. Some borrowers are thought to pay as much as 60 per cent.

Richard Holden, professor of economics at the UNSW business school in Sydney, told AFR Weekend that while he wouldn't defend banks for the bad behaviour exposed by the commission, there was a risk the fallout could make things worse.

"Whatever you think about sunshine as disinfectant, my household disinfectant won't lead to a massive risk for 25 per cent of the Australian stock market and create systemic risk," he said.

Professor Holden said the commission should be a catalyst for greater competition and reforms that make it easier for customers to switch banks.

"If what we're adding to the mix is subprime, and these quirky products, I'm not sure that does make things better."

Fintech business lending is largely unregulated, and new players can earn high margins because they don't need to carry big capital buffers like the regulated banks do.

"Right now fintechs are great because they don't have to hold regulatory capital," said Fidelity portfolio manager Kate Howitt. She equated most fintech models to a form of shadow finance, and suggested when market conditions deteriorate, fintech bad debts will rise.

"In a downturn, you're really happy if your financial institution holds regulatory capital" and "obviously nothing beats a bank in a downturn", she told the Morningstar's investment conference in Sydney on Thursday.

But calls are growing for this new breed of fintechs to improve disclosure to ensure business borrowers that turn to them know what they are getting into.

While Prospa's prospectus discloses the annual average interest rate in a footnote, it communicates to customers using a "factor rate" that makes the rates look around half of what they actually are.

For example, a customer borrowing $10,000 and repaying $12,300 over 12 months is on a factor rate of 1.23 times. However, this equates to an annual percentage rate of 42 per cent.

"Fintech lenders have moved beyond their start up phase and are now a genuine alternative source of debt funding for many SMEs," said Neil Slonim, an independent advocate who has been working with the Australian Small Business and Family Enterprise Ombudsman and FinTech Australia to lift fintech lending standards.

"Borrowers are entitled to be able to readily tell how much a loan will cost and whether they can get a better deal elsewhere. On this front, Prospa has some way to go," he said.

Prospa and other online business lenders are currently working with the small business ombudsman to finalise a new code of conduct, which is understood will see interest rates disclosed based on the annual percentage rate along with alternative methodologies, so borrowers can make like for like comparisons.

The corporate regulator is also getting more active to police the start-ups to ensure they are adhering to stricter standards like the banks.

ASIC wrote to FinTech Australia, the industry lobby group, earlier this last week, saying it expected start-ups to adhere to new unfair contract terms legislation introduced to improve standards in the banks.

Federal opposition spokesman for the digital economy, Ed Husic, said Fintech is an opportunity as much as it is a threat, but warns the industry will need to stay clean.

"The reason fintech is growing is because a lot of the disruptors have gone into regulation-heavy, or profit-heavy, sectors where customers are unhappy, and have worked out that they can potentially come up with an offering that consumers will flock too," says Husic.

"This is why Prospa has emerged. The banks weren't offering product that suited small business."

Husic adds that the fintech industry adheres to its social licence and "that their behaviour matches the expectations of the community".

"There are a lot of people in Australia's fintech community that are really focussed on coming up with products and services that give consumers a better deal.

"Their great work can't be undermined by any fly-by-nighters."

Neil Slonin, a former National Australia Bank executive who runs theBankDoctor blog and in February helped the federal government produce a report into fintech, challenged this week what he described as a lack of transparency in the unregulated non-bank SME lending market.

"Fintech lenders have moved beyond their start up phase and are now a genuine alternative source of debt funding for many SMEs," Mr Slonin wrote this week.

"There is no doubt the upside for the leading player in this transformational market is very significant.

He said only "time will tell" whether Prospa, whose accounts show it recorded in 2017 revenue of $56 million against net profit after tax of $1.2 million is worth its $576 million IPO price tag.

"There are many factors which will drive Prospa's share price but none are more important than its genuine commitment and adherence to transparent and responsible lending practices."

Leo Tyndall, founder of marketplace lending platform Marketlend, warned in The Australian Financial Review this week that the fintech industry "is still a Wild West, where start-ups are operating in the absence of real oversight that will protect SMEs from predatory tactics and help a mature funding alternative emerge."

The value of lending by fintech business lenders in Australia has grown significantly, from approximately $15 million in 2013 to over $470 million in 2016, according to KPMG.

Prospa, which has around half of the market share, said it expects to originate $385 million in new loans in calendar 2018, up 34 per cent from the $288 million written in 2017.

But this is still minuscule compared to banks, which have loans to small businesses (where the amount is under $2 million) of around $260 billion.

Prospa is among a range of fintech start-ups lending to small business, including Moula, Spotcap, Kikka, OnDeck, Get Capital, CreditSME, Banjo, Sail, Apositive, RateSetter, Bigstone, ThinCat, InvoiceX, Waddle, FundX and Timelio.


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Guest Thursday, 12 December 2019