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RCL a life saver for small businesses choked for credit

Small businesses are looking at how they can recover and obtaining credit is essential. Despite the Australian Government setting aside $40 billion for small business loans and guaranteeing 50%, businesses are not borrowing, and bank lending is down. Only 4.5% of the Government’s SME Guarantee Scheme funds have been utilised.

In a sea of uncertainty, essential funds are not flowing for many of Australia’s 2.5 million businesses, with most of them being small businesses. It is a difficult time to borrow, just when the need for financial support for business is at its greatest.

The combination of COVID-19 uncertainty, a post-Royal Commission into Financial Services environment, regulations put in place after the Global Financial Crisis, and caution around the Australian Financial Complaints Authority have meant that even with both a relaxation of responsible lending obligations and a guarantee by the Government to cover 50% of defaults, small businesses are finding it difficult to access funds.

It is time to ask: is there a different way to help small business access finance?

A Revenue Contingent Loan (RCL) for business is a financial instrument in which money is provided to eligible firms in the form of a loan. However, the loan has a critical feature which is quite different to normal commercial lending, including the Government’s SME Guarantee Scheme- RCL repayments of the debt are required if and only when the firm has a comfortable capacity to repay.

In concept the idea is similar to the Higher Education Contribution Scheme (HECS), in which students are provided with a benefit, in the form of not having to pay tuition upfront for a university degree, which is then paid when graduates are able to afford to do so depending on their income. This provides people the comfort that they will not have to repay the loan in financially adverse periods.

An RCL would also provide insurance to a small business debtor, and in this way HECS and an RCL have in common protection against the consequences of loan repayments when financial circumstances are adverse. However, it is conceived that the RCL will operate quite differently to HECS in practice, as explained below.

RCL Summary

§ The problem is uncertainty: banks are not lending, and businesses are not borrowing.

§ Without accessible finance, many businesses will struggle to rebuild and recover from COVID-19, slowing both economic recovery and jobs growth. While it is a small business problem, it is a BIG problem for Australia.

§ vThis problem is impacting nearly a million business (who have experienced a >30% revenue decline) and this impacts over half the Australian workforce. While it is mainly a small business problem, it is a BIG problem.

§ One solution is a loan that can cope with uncertainty and financial stress – something like the Higher Education Contribution Scheme (HECS), which has been in place for 30 years.

§ This idea could be adapted for small businesses.

§ RCL removes time as a determinant of the loan repayment obligation because loan repayment obligations are contingent on revenue.

§ If a business can get some flexibility around repayments, a lot of the risks associated with uncertainty are minimised.

How it works

§ An RCL is repaid based on the business revenue at a low rate, say <5% of annual revenue.

§ RCLs would be small loans, capped at, say, <$200,000 and tied to the businesses’ past revenue.

§ A small surcharge of, say, <10% would be charged to cover the costs including the risk of less-than-full repayment of the RCL from some proportion of borrowers of running the scheme.

§ The Government would initially administer the scheme, having the associated legislative and administrative capacity.

§ There is about $38B in unused funds that could be diverted from the Government’s undersubscribed SME Guarantee Scheme to an RCL trial.

§ The Government can use existing revenue reporting facilities, like a Business Activity Statement (BAS) to collect repayments.

§ Just like a normal loan, business applicants to be eligible must establish their trading and credit histories, repayment capability and good character. If the purpose is to buy major assets the borrowing will be a percentage of the total cost (they will need a deposit) and security against business or personal assets.

§ The Government is not competing with the banks, as the banks are essentially not lending to the sector.

§ The scheme would be limited to a COVID-19 response and assessed for its useability in the future contingent on outcomes.

Detailed discussion paper link here.



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