The financial system is inefficient
Australia’s financial system is dominated by banks and superannuation funds. It is also tightly supervised and regulated. This architecture has provided attractive returns to investors, and security and confidence to deposit holders. However, from a business perspective, it has also resulted in a culture of risk aversion and a bias against lending to SMEs.
An efficient financial system is one that meets the needs of financiers, households and business. In Efic’s experience, small to medium enterprises (SMEs) and businesses of all sizes operating in emerging and frontier markets, cannot consistently access the finance they need to succeed.
- Funding requirements of SMEs — particularly those which are innovative or growing rapidly — do not fit into the standard criteria, or the model-based lending approach adopted by banks, given the small amounts involved and the lack of security and readily available information on borrowers’ abilities to perform. Australia’s regulatory settings also bias banks against providing credit to SMEs.
- Australian companies looking to take advantage of opportunities in emerging and frontier markets also face financing handicaps. The international focus of Australia’s banks is more limited than that of many of Australia’s exporters resulting in financing shortfalls. Financial flows into emerging markets also suffer from short-termism; exposing exporters and investors to abrupt and wholesale credit withdrawals when sentiment changes.
Australian SMEs and transactions of scale in emerging and frontier markets are likely to remain undersupplied for finance in the foreseeable future. This reflects a number of factors including: the specialised and ad hoc nature of the financing required; the strong demand for capital elsewhere; the centralised nature of Australia’s financial system; and the relatively narrow business models of the major banks.
At the margin, Government can improve the allocative efficiency of capital
As a commercially run Government-owned Export Credit Agency (ECA), Efic can ensure finance is available for the benefit of exporting SMEs and those companies, both big and small, willing to take risks and expand into emerging and frontier markets. For more than 50 years, Efic has shown that this can be done profitably and without distorting the broader financial market. While not always best served by private financiers, such companies are important for Australia’s future growth, innovation and productivity. Exporting SMEs account for around 10% of total exports by value, while emerging and frontier markets are becoming the driver of the world economy.
Export credit agencies are an important part of the financial architecture
Australia’s major trading partners are aggressively using their ECAs to grow export revenues and employment. In 2012, ECAs in the OECD and the major non-OECD economies (China, India, Russia and Brazil) provided around US$300b in medium-long term export finance and insurance. ECAs have the capability to provide long-term financing, with their support tied to the export of goods or services, or to secure long term supply of materials or energy for their domestic industries. In this environment, countries that do not have a strong and active ECA may handicap their exporters.
Australia has also been a beneficiary of ECA financing. Since 2009, foreign ECAs have committed around $40b to the development of Australian resource projects and related infrastructure. In some of these projects the amount of finance required — particularly LNG projects — was beyond the capacity of private financiers, particularly at the tenors that more closely match the long life of these assets.
Selectively, Efic can be catalytic in ‘crowding in’ this vital foreign capital as some providers perceive Efic’s participation as lowering risk due to: its government ownership; understanding of the Australian legal and environmental framework; and strong bilateral relationships. More importantly, and more frequently, Efic is able to obtain reinsurance from the private market in transactions in emerging and frontier markets, where those reinsurers would not normally take risk without Efic’s participation.