How small business firms select a bank

How small business firms select a bank

INTRODUCTION

In the past 20 years, the banking industry has undergone significant change throughout the world. Mergers, especially in the United States, and changes in banking supervision have created an environment in which some, but not all, segments of the banking industry have flourished. These changes have been due to a number of factors, the major ones being: the general deregulation of the banking industry in many countries; international agreements on capital structure; countries moving to floating exchange rates; the rapid change in technology; and internationalisation of world financial markets.

For small business firms, banks represent an important and almost indispensable business partner since they facilitate numerous functions necessary for their survival. For example, they provide cash management services, they arrange letters of credit to assist in obtaining trade credit, they facilitate both domestic and foreign exchange transactions, and they also provide financing through loans. Many small business firms are characterised by a lack of capital and banks play a vital role in financing growth. Ferrers (1995) suggests that obtaining financing is a major problem facing small business firms. Binks and Ennew (1996) found that inadequate financing, particularly long-term debt financing, was a major factor constraining growth of the small business firm.

In Australia in the early 1980s, the government announced it would grant banking licences to foreign banks. In order to obtain the licence, overseas-owned banks were required to submit a comprehensive proposal. Since the Australian political environment is particularly sensitive to the needs of small business firms, a specific part of each proposal had to address how the bank would service the small business market. The Australian Government has also publicly stated that mergers between any of their large national banks are prohibited until there is sufficient competition in the small business lending market.

For banks, small business lending can be a high-risk proposition due to the undercapitalisation of many small business firms. Milligan (1993) suggests that small businesses believe that they have been badly served by bankers in recent years. Keasey and Watson (1993) suggest that the media coverage of conflicts between small firms and banks in the United Kingdom indicates that banks are currently not highly regarded by their small business customers. On the other hand, some in the banking industry see small business lending as an opportunity to make a good rate of return. Clark (1987) and Bean (1993) suggest that small business lending can be highly profitable and many banks have been unable to tap this potential fully.

In order to shed some light on the changes that are taking place in the US banking industry market structure, and how well the small business customer is being served, this study compares the factors small business firms consider important in the bank selection process in both the United States and Australia. To date, much of the work in banking has focused on what is taking place in the United Kingdom and Europe. By extending the investigation to Australia, additional insight may be possible. The political climate in Australia is particularly sensitive to the needs of small business firms. In addition, the Australian banking industry has been dominated by four major banking organisations since 1985. With the number of banking consolidations currently taking place in the United States, the industry may soon be dominated by only a few large banking firms.