Easier credit would drive small caps

The one thing that investors can’t ignore in 2020 is business confidence. Companies that initially list on the ASX tend to be smaller companies that are keen to pursue growth. If business leaders are lacking in confidence and are hesitant to invest for the future, shareholders tend to become restless and share prices subsequently decline. 

This is not lost on our Treasurer Josh Frydenberg who, in an opinion piece for the AFR back in August this year, stated;

“With Australian corporates enjoying healthy balance sheets, low borrowing costs and strong equity market conditions, the question is are they aggressively enough pursuing growth?”

The clearest example of the aversion to growth is that bank lending to Small and Medium Enterprises (SME), which is the engine room of the Australian economy, has all but stopped. Have we lost our nerve or do SME’s have structural growth impediments?

Current regulations allow the major banks to apply a risk weight of just 37% to their loan books whereas Bendigo Bank, who has been lending money to Australian’s for 160 years, must use a risk weight of 52%. 

The major banks are therefore prioritising their lending efforts towards under-geared households and big businesses where superior risk-adjusted returns can be generated.

Perversely, SME’s are required to pay an interest rate that is more than 1.6x higher than their larger competitors in order to deliver appropriate risk-adjusted returns to the major banks. This means that SME’s have an uncompetitive cost of capital and have little motivation to pursue growth.

If Australia is going to prosper in 2020 then SME’s access to competitively-priced debt will need to improve. Risk weights for lending will need to be adjusted in favour of the non-major lenders. 

If this happens then we believe that business confidence will improve in 2020 and solid returns from small-cap companies should be expected. 

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This wire is part of the ‘One thing investors can’t ignore in 2020’ series. To download the full ebook please click here.