With inflation at a thirty-year high, past behaviour is no longer a sufficient predictor of borrower serviceability.
Our current macroeconomic climate of higher interest and inflation isn’t strictly novel. But it is something we haven’t seen in Australia for many years. The Reserve Bank of Australia indicates that inflation this year has attained a thirty year high. This tells us a couple of things:
Firstly, that many members of our workforce are now operating in a landscape of risk that’s totally unfamiliar to them.
And secondly, that the last time Australian businesses experienced this kind of risk landscape, the data resources available to lenders were fewer, lower-quality, and less sensitive.
Those factors together mean that now is a great time for lenders to revisit their borrower research practices.
This macroeconomic climate is hitting small and medium businesses harder than their larger cousins. While increased costs are the cause of most of the challenges that attend inflation, the monetary policy designed to remedy it is a blunt instrument. Contractions in demand might have a cooling effect on the economy at large, but they can squeeze small and medium enterprises (SMEs) into non-existence. The construction industry, for example, relies on long and fraught international supply chains and fixed-price contracts, and has suffered decade-high insolvencies.
When a business loan is taken out, a credit check is supposed to ensure that a business can service that loan—today and, hopefully, several years into the future. A business credit score, by its nature, uses historical behaviour as a predictor of future behaviour. It uses metrics like payment history and the length of a company’s credit history to arrive at a number that is theoretically predictive of a company’s ability to service its loans.
But is that predictive?
If inflation hasn’t been this high in three decades, it’s not a stretch of the imagination to see how a ten-year credit history may no longer exert the same predictive weight in today’s context.
Business credit scoring is a tremendously useful tool, but as the lending environment shifts with the pressures of macroeconomic forces, it can’t be the only tool. That’s where new information sources, paired with the smart analytics that can transform them into quality insights, come in.
Information about businesses in Australia is often public, and although it can be laborious to collect and interpret on a case by case basis, top-performing companies still understand the value of putting data in the driver’s seat. The combination of credit history and industry risk might not provide the full story. Assessment of larger loans, in particular, might want to account for other factors, like relationships between companies, the histories of company leadership or news media reporting.
The strange new landscape of SME lending in Australia poses a challenge for lenders and borrowers alike. A business that can service its loans right now might not be as fortunate in twelve or eighteen months’ time, given rising costs and fickle demand-side factors.
Smart lenders will be looking for additional information to make truly robust assessments of their potential borrowers.