Commonwealth Bank has bowed to public pressure and removed contract terms that allow it to put small business borrowers into default, even if they have not missed a repayment.
But the lender did not go as far as recommended by small business ombudsman Kate Carnell, who called for banks to remove such contract terms from all loans of less than $5 million.
Instead, CBA will on Friday pledge to remove contract terms that allow "non-monetary defaults" by small business customers who have borrowed up to $3 million from the lender. CBA said this would cover 95 per cent of its small business customers.
Ms Carnell, Australian Small Business and Family Enterprise Ombudsman, who last year led an inquiry into small business lending that recommended the practice be banned, welcomed CBA's move. It is the first formal response from a big bank to this recommendation.
"It should be $5 million, but that said it is a very good step," Ms Carnell said. "We are really pleased that CBA has decided to take a unilateral step."
One of the most controversial features of small business lending in recent years has been the ability of banks to put customers who are still meeting their loan repayments into default. Banks can do this through loan contract conditions known as "financial indicator covenants".
Farmers raised this issue as a key concern in a previous parliamentary inquiry, while customers of CBA-owned Bankwest have also repeatedly highlighted the practice through various inquiries.
Of particular concern to Ms Carnell's inquiry was a practice in which banks could put a loan into default if the loan-to-valuation ratio fell below a certain level – which can occur if a property is revalued by the bank.
CBA's group executive for private banking, Adam Bennett, said financial indicator covenants would no longer be included in "almost all" of the bank's small business loan contracts.
"Even though we very rarely used these covenants as a reason to foreclose a loan, this means that we will be removing all references to them in our small business loan contracts where our exposure to the customer is below a value of $3 million," Mr Bennett said in a statement.
"This means customers will have more certainty and control so they can avoid defaulting on their small business loans," he said.
CBA said it would still be able to make non-monetary defaults in some circumstances, such as if a customer used the loan funds illegally, they became insolvent, or failed to maintain insurance.
CBA is the only major bank to formally respond to this recommendation so far, Ms Carnell said. Westpac told a recent inquiry it would look to eliminate these clauses from loan contracts and ANZ also said such clauses should not apply on loans up to $3 million. National Australia Bank had been less forthcoming, Ms Carnell said.
The government's banking inquiry chaired by Liberal MP David Coleman last week recommended that if banks did remove non-monetary default clauses by July this year, the government should ban the practice in small business lending.