The Australian Bankers' Association (ABA) said it is vital to the health of the Australian economy that banks apply risk-based pricing in relation to lending to small businesses.

The ABA will today outline its position in Canberra to the Joint Committee on Corporations and Finance's Inquiry into access to small and medium-sized businesses to finance.

ABA chief executive Steven Münchenberg said: "There is no doubt that small businesses have had a tough trading period throughout the global financial crisis and are still dealing with its impacts."

"Weaker trading conditions can undermine small business balance sheets due to reduced revenues. Unfortunately, some small businesses have experienced cash flow problems, and in some cases, this has caused banks to decline loan applications because of the businesses' reduced ability to repay their loans."

During the GFC, when trading conditions for small businesses deteriorated, banks rightly re-priced for risk when lending to this sector.

Mr Münchenberg said: "Banks must lend prudently. They must do this to comply with prudential and responsible lending regulations, as well as meeting commercial objectives for their shareholders. Capital required by the Australian Prudential Regulation Authority (APRA) to be held by banks for small business loans is generally three times higher than for home loans, and can be seven times higher for some products. We have to remember that it was irresponsible lending in the US that was the trigger for a lot of the global financial problems."

"Your business needs to make a profit, so does a bank. When you approach a bank for a loan, you are asking the bank to go into business with you. You are asking the bank to consider your business plan, agree with your strategy, approve your expenditure and accept some of the risk that the business may not succeed. Banks are in the business of supporting sound and viable financial decisions, therefore every request is considered on its own merits and priced accordingly."

Access
Compared to the height of the GFC, small businesses are now increasing their appetite for taking on new debt and banks are supplying the finance.

The past two quarters, June 2010 and September 2010 have seen comparatively strong lending volumes of $22.1 billion and $20.6 billion. These past two quarters combined make up the second strongest six-monthly period of new lending activity, for loans under $2 million, on record.

Many banks have undertaken extensive advertising campaigns aimed at the small business sector and a number of banks have announced significant expansions in the hiring of business bankers.

Cost of finance
Since the credit crisis started, banks have faced continual pressure on their cost of funds. The three sources of funding: deposits, short-term funding, and long-term funding have all contributed to this pressure, although short-term funding is starting to ease. This pressure is affecting the prices of all loans including small business.

Banks also build in a risk premium to cover the higher probability of default of business loans.

Reserve Bank statistics show that 90 days arrears for banks lending to unincorporated businesses were 2.6% as at June 2010 (the most recent data available). This compares with 0.7% for home loans.

Mr Münchenberg said: "History has proven that small business enterprises have a higher probability of default compared with retail home loan customers and banks experience higher levels of loss. A higher risk margin is therefore required on business loans to cover this increased risk."

"The difference between the home loan rate and business rates which are secured by residential property is a direct result of the higher probability of default and higher losses experienced by the banks in the small business sector. Again, this is a prudent approach by banks."