SMEs crucial to Europe’s economic and job stability

‘Regulatory’ and ‘mentality’ changes are needed to ensure growth and investment in SMEs, argues Philippe De Backer

By Philippe De Backer

27 Sep 2014

SMEs today account for more than 98 per cent of Europe’s business and provide more than 67 per cent of jobs in the union which makes them the most important drivers of European long-term economic growth and sustainable job creation. A recent study by the European central bank reported a deterioration in the availability of bank loans, and indicated a marginal decline in the rejection rate for eurozone SMEs applying for a loan. The survey furthermore suggests that financing conditions for SMEs continue to differ significantly across euro area countries and are, in general, more difficult than those of larger companies.

There are three key issues that cause the credit channel to malfunction: quantity, price and geographical location. In terms of quantity, the aggregate loan growth continues its steady deceleration and remains very heterogeneous across the euro area, caused by higher capital requirements and stricter risk assessment regulations for banks that lead to a tight credit regime. This affects businesses, in particular SMEs that are dependent on bank lending and have little access to alternative sources like bigger corporations.

“SMEs need practical help to understand their long term growth financing options and make themselves attractive to investors”

When we look at the price that businesses pay for financing we see a fragmentation of the market. The EU’s monetary policy, such as the recent lowering of interest rates, is not passing through to bank lending rates in a number of member states as their interest rates are based on perceived solvency where the bank is located and reflected by sovereign bank yield. Furthermore, smaller firms appear to be suffering more from price and quantity effects, especially in weaker economies. The geographical location of the firm and risk profile or risk appetite of banks emerges as a decisive factor in lending and investment. As a consequence, credit is allocated away from the smaller and younger firms that are by nature more risky, yet create the most net jobs.

As for possible solutions; first of all, the role of banks in providing SME finance can be structurally improved by connecting SME financing needs with the funds of banks and non-bank investors via securitisation of SME loans. This can assist banks’ ability to fund and bridge the gap between deleveraging banks and investors seeking to diversify their portfolio. In addition, the asset quality review will help clean banks’ balance sheets and reassure the markets about the stability of European lenders, which will hopefully help banks to begin lending again and will also close the gap in lending rates between member states.

“There are three key issues that cause the credit channel to malfunction: quantity, price and geographical location”

Second, and even more importantly for the long run, the EU needs to create diversity in the funding landscape, in particular through capital markets. Currently, 80 per cent of EU business finance is bank-led, but in the US a majority of SMEs are financed through well-developed capital markets. The new commission should make it a priority to enable capital markets to function better and provide the necessary additional financing companies need. Today, there is already a trend emerging rapidly for larger corporates with corporate bond issuance. But also private placements and other forms of quasi-equity are on the rise.

Last but not least, the European commission should review how the access to the EU programme for the competitiveness of enterprises and SMEs and Horizon 2020 initiatives could be improved, such as enhancing communication, increasing budget allocation to financing SMEs and reducing red tape. The procedure for applying for funds may take up until 18 months. In business, where time is essential, this timeframe could kill entrepreneurship and innovation.

The commission should enable a regulatory environment that supports SME growth markets. An analysis of the regulatory framework should be done to examine any possible improvements. There are a lot of initiatives where we can deliver a supportive regulatory environment for SMEs if we ensure political and technical coordination, also involving the SME ecosystem. In addition, it is important to re-catalyse the SME advisory ecosystem, which includes issuers, investors, entrepreneurs and academics. SMEs need practical help to understand their long-term growth financing options and make themselves attractive to investors. This will require regulatory change, but also a mentality change, as entrepreneurs should be more open to alternative forms of finance.

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