Benoît Coeuré: SME financing, market innovation and regulation
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,
at the plenary Session 11 "Challenges and feasibility of diversifying the financing of EU
corporates and SMEs", at the Eurofi High Level Seminar, organised in association with the
Irish Presidency of the Council of the EU, Dublin, 11 April 2013.
* * *
I wish to thank Annalisa Ferrando, Petra Köhler-Ulbrich and Balázs Zsámboki for their inputs. I remain solely
responsible for the opinions contained herein.
Why SMEs are special
Small and medium sized enterprises (SMEs) are special. They are the backbone of the euro
area economy: they constitute about 98% of all euro area firms, it employs around
threequarters of the euro area's employees, and they generate around 60% of value added.1
These figures happen to be even higher in those jurisdictions which have been most affected
by the crisis.
SMEs are also specific in their financing structure. They turn more often to banks for their
external financing than large firms but, at the same time, they are generally more likely to
experience greater difficulties in obtaining funds. There are structural reasons for this,
notably they are more opaque and their corporate capabilities more difficult to assess,
because their financial statements are less informative and their credit histories are usually
shorter. These characteristics are compounded by fixed costs in external assessment and
monitoring. All this leads to higher transaction costs, especially those stemming from
asymmetric information, for SMEs.
It is therefore to some extent inevitable that credit sources for small firms tend to dry up more
rapidly than for large companies during economic downturns, thereby disrupting the business
and investment activities of these firms to a greater extent.2 And this has indeed been the
case during the crisis in the euro area. The creditworthiness and financial health of SMEs
have deteriorated more sharply than those of large firms, and the protracted period of weak
economic conditions has exacerbated the asymmetric information challenges of SMEs. The
statistics currently available do not provide timely and high-frequency hard data on the
balance sheet position of a representative set of SMEs for the euro area. Yet, based on
survey information provided by the ECB (the Survey on Access to Finance of Enterprises,
SAFE), we see that SMEs' profits, liquidity buffers and own capital have developed less
favourably than have those of large firms during the crisis3 (Charts 1 and 2).
From the viewpoint of commercial banks' risk management, it may thus be partly
understandable that banks take a more selective approach in supplying loans in a recession
in order to preserve the quality of the asset side of the balance sheets. But, in general, such
credit tightening currently appears to be very severe for SMEs, because they are perceived
by banks to have a higher probability of default than larger firms, and because SMEs are
often unable to switch from bank credit to other sources of external finance.
As a result, SMEs are more likely to be affected by excessive bank risk aversion and thus by
outright rationing of credit provision than are large firms. Difficulties in borrowing, which
influence not only their day-to-day activities, but also their ability to grow, may then easily
transform liquidity constraints into solvency risk.
To illustrate this point, two facts are worth mentioning. First, SMEs tend to face higher costs
for bank finance. A simple comparison between small loans (typically to SMEs) and very
large loans (typically to large corporations) shows that euro area SMEs were paying on
average around 160 basis points more than large euro area companies in the six months up
to January 2013.4 There is also a substantial divergence across euro area countries which
has worsened since the beginning of the financial crisis (Chart 3). For instance, in the same
period, the spread was around 50 basis points for SMEs in Austria and Belgium, but 261 in
Spain and 174 in Ireland. Just to put this in a "historical" perspective: between 2003 and
2008 the same spread was 84 basis points in the euro area, 79 basis points in Spain and
44 basis points in Ireland.
The second fact that is worth mentioning is the higher rejection rates of loan applications of
SMEs, as the ECB survey shows (Chart 4). SMEs are systematically reporting that they face
more financing obstacles than large firms across major euro countries (except here in
Ireland, where firms are reporting to be highly constrained irrespective of their size). This
appears, at least in part, to be related to their financial position. Indeed, when linking
information on the financial health of SMEs with the actual financing obstacles they
experience, it turns out that firms in countries with higher leverage and interest payment
burdens as well as lower profits tend to be more affected by financing obstacles than SMEs
in other euro area countries (Chart 5).
However, it is worth noting that in conjunction with credit constraints, several other issues
have an impact on the environment in which SMEs operate. For instance, they are more
affected by downward trends in the economy and structural rigidities, i.e. a lack of demand
for their products, high input prices, unfavourable regulation, heavy administrative burdens,
inflexible labour and product markets, etc. Since such factors differ across countries, the
financing costs of SMEs will inevitably also vary across the euro area. Obviously, the
Eurosystem cannot influence these factors.
In periods of binding bank lending constraints, a mitigating factor is the ability of corporates
to replace bank credit with alternative sources of financing. Since the outbreak of the
financial crisis, internal financing and external financing instruments other than bank loans in
general have increased in importance relative to bank loans. Depending on the financing
environment, substitution effects have differed markedly across euro area countries
(Chart 6). On the one hand, enterprises have replaced bank loans with market-based
financing or financing via unquoted equity during the crisis. In this respect, the relevance of
debt securities has increased, especially in some countries, such as France. On the other
hand, inter-company loans have gained importance in other countries, such as Germany. In
the same period, trade credit appears to have taken on a buffer role in some euro area
countries.
We know, however, that some of these substitution activities have mainly affected larger
companies, as in the case of debt securities, while trade credit, leasing and factoring are
closer substitutes to loans for SMEs (Chart 7). But trade credit, leasing and factoring are
strictly related to the business activity of companies and in recessions their buffer role might
be limited by the reduction in the exchange of goods and services.
Taking a macroeconomic perspective, credit supply conditions have certainly been found to
have an impact on real economic activity during the crisis. Analyses carried out by ECB staff5
suggest a rather limited contribution of credit supply conditions to euro area economic activity
between 2007 and the first quarter of 2008. By the fourth quarter of 2008, however, the
impact of credit supply conditions appears sizeable. At the peak of the crisis, namely in the
first half of 2009, model-based analysis points to credit supply effects accounting for an
almost 2- percentage-point contraction in annual real GDP growth, namely around one-third
of the overall contraction. As the sovereign debt crisis unfolded, credit supply factors turned
detrimental to growth again. In this context, riskier borrowing segments are highly vulnerable
to the self-reinforcing dynamics of weak economic conditions, low financial buffers and tight
bank lending policies. Actually, the Eurosystem Bank Lending Survey shows over the recent
quarters that both healthy and stressed banks report risk perceptions as their main concern
and significantly tighten margins on riskier borrowers.
Policy actions supporting lending to SMEs
During the crisis, the ECB took exceptional monetary policy actions, distinguishing between
standard and non-standard measures. Standard measures have included the reduction of all
key interest rates. Non-conventional measures have comprised fixed-rate full allotment mode
in refinancing operations, the lengthening of the maturity of such refinancing operations up to
36 months, the extension of the list of eligible collateral (see Chart 8), the liquidity provision
directly in foreign currencies, the reduction in the reserve requirements from 2% to 1%, the
covered bond purchase programmes, the securities market programme, and, finally, the
announcement of the outright monetary transactions. Such actions have proved to be
effective in alleviating bank funding constraints, containing the risks of a disorderly bank
deleveraging process, and supporting the effective transmission of interest rates across the
euro area, amid a dysfunctional financial market. These measures were exceptional in
nature, scope and magnitude, and yet appropriate for the severity of the circumstances.
These interventions have served to considerably ease the downside pressures to price
stability by avoiding an abrupt credit crunch stemming from sudden shortages of liquidity and
funding for banks. However, at times, the effectiveness of monetary policy itself has been
hindered by financial fragmentation, in particular against the backdrop of a sovereign debt
crisis in some euro area jurisdictions. As a result, the accommodative monetary policy stance
set by the Governing Council has affected firms rather unevenly. The ECB will provide ample
liquidity as long as needed, but market participants have to continue their efforts to facilitate
the transition to a less central-bank reliant, more market-based financial system.
Against this background, attention has turned to the role of public policies in reducing
impediments and unclogging credit channels towards SMEs. As a first measure, most
governments have expanded credit guarantees to SMEs for the purpose of inducing banks to
reopen their lending facilities, thereby reducing the risk that banks need to take on their
balance sheets when granting new loans. Other measures have tended to stimulate the
chronic shortage of supply of capital into new seed, start-up and early-stage firms. Venture
capital (VC) funds have been channelled through public/private co-investment VC funds
managed by private sector fund managers. Innovative instruments have included the
promotion of investment in SME equity to cope with the undercapitalisation problem. Some of
these measures have a longer-term structural perspective, rather than something that can
address the immediate conjunctural weakness of SMEs.
Overall, loan schemes, especially guarantees, tend to have a much larger impact in terms of
the number of firms affected, while venture capital and similar schemes are much more
targeted and restricted to specific groups of firms. However, they have proved to be of limited
effectiveness in stressed countries, given the higher funding costs faced by stressed
sovereigns themselves.
In terms of impact, while governments have strengthened their support measures for SMEs
during the financial crisis, it seems that SMEs in most countries have not yet seen a visible
improvement, at least based on evidence from survey results (Chart 9). Apparently, while a
range of government support measures exists for alleviating SMEs' access to finance, it has
proved difficult to reach the policy targets, i.e. the SMEs.
Beyond government financing instruments to support SMEs' access to finance, other policy
actions may be considered. This includes the development of deeper capital markets
accessible also for SMEs and a wider use of ratings for SMEs. In addition, combating
payment delays in trade credit financing helps to alleviate liquidity constraints and has
already been put in place in some countries.
Besides governments, supranational institutions also offer support measures to SMEs -
measures which could be enhanced. Traditional instruments of intervention are related to the
European Investment Bank (EIB) lending to SMEs6 and the European Investment Fund's
(EIF) actions in the ABS market designed to revive investors' interest and confidence, by
facilitating large and liquid transactions. An interesting pilot project on trade finance was
launched by the EIB in December 2012 for Greece. For the first time, the EIB is involved in a
short-term credit support instrument.
The regulatory framework
In addition to direct support measures by national governments as well as by European and
international institutions, the regulatory framework may also have an impact on the incentives
of banks regarding their exposures to SMEs. Let me note in this context that the European
Banking Authority (EBA) has recently published a detailed analysis of the estimated impact
of banking solvency regulation on SME lending, with a particular focus on the relevant
provisions of the forthcoming capital requirements legislation in the EU7 In this regard, a clear
distinction should be made between micro- and macro-prudential policy objectives and tools
that may have relevance for supporting SME lending.
From a micro-prudential perspective, minimum capital requirements and the underlying risk
weights can be considered as the main factors potentially affecting banks' incentives to lend
to SMEs. In the current regulatory framework, there are different provisions affecting SMEs,
depending on whether a standardised approach or more sophisticated approaches are used.
As regards the standardised approach, loan size plays an important role when defining the
risk weight and thus the pertinent capital requirement. To clarify: small-sized loans up to
€1 million are treated as retail exposures, and benefit from a lower risk weight of 75%,
compared with a risk weight of 100% for unrated corporate loans. Hence, the current
regulation treats small-sized loans, which are likely to be taken up mainly by SMEs, in a
more favourable manner.
However, for larger (over €1 million) loans there is no favourable treatment for SMEs under
the standardised approach. For unrated loans exceeding €1 million, the treatment of
exposures to SMEs and large companies is the same. Only companies with good credit
ratings - which are typically larger corporates - benefit from lower risk weights.
Importantly, for banks using the more sophisticated approaches for credit risk, namely the
advanced internal ratings-based (IRB) approaches, the current regulatory framework further
provides for preferential treatment of SME loans vis-à-vis large corporate exposures.
The Capital Requirements Regulation and Directive, or CRD IV, entails a significant increase
in the quality and quantity of capital. While the phasing-in is rather long and expected to end
in 2019, the implementation of various capital buffers and the higher level of minimum capital
requirements - though clearly beneficial for enhancing financial stability in the long term -
are estimated to increase the overall cost of funds. This is likely to be reflected in the interest
rates charged to all clients, including SMEs.
Aware of the potential implications for SMEs and with the aim of partly neutralising the
potential adverse impact of increased minimum capital requirements, EU co-legislators have
agreed on the inclusion of a specific discount factor for exposures to SMEs, for loans up to
€1.5 million. This measure is expected to reduce capital requirements for SMEs by about
25%.8 The ECB supports this proposal and considers it as an important policy tool that may
help SMEs in their access to bank finance.
Taking a long-term perspective, together with micro-prudential considerations, the CRD IV
will also provide a harmonised legal framework for a range of macro-prudential tools. In this
regard, the first policy tool that is explicitly designed to address systemic risk is the
countercyclical capital buffer, which will be phased in gradually from 2016 onwards. While the
primary objective of this buffer is to enhance the resilience of banks by building up buffers in
periods of excessive credit growth that can be released when the system as a whole is in
distress, a positive side effect of the application of the measure is that it may contribute to
smoothing the credit cycle, thus providing funds for corporate clients, including SMEs, also in
recessions. This however also implies that as long as we do not have sufficient capital
buffers that could be released to absorb losses or to loosen prudential measures regulated
by EU law, the use of macro-prudential tools to support SME lending is very limited.
Finally, in a broader context, there is a need for structural market innovation to improve SME
financing. Such an innovation would create a market for asset-backed securities, where the
underlying assets are loans to SMEs. It could also support the revival of this market segment
by increasing its transparency and therefore investor confidence. Having access to a
diversified source of finance for SMEs will enhance their resilience through the business
cycle. Because SMEs are characterised by their relatively small size and because it is costly
to collect information on their projects, they have limited access to capital markets. In this
context, securitisation offers an opportunity for the custodians of large pools of European
savings, i.e. insurance and pension funds, to channel resources to SMEs. In this vein, the
efforts put in place in the Prime Collateralised Securities (PCS) initiative should be
commanded. The PCS has defined common criteria on standardisation, quality, simplicity,
and transparency with the aim to improve market depth and liquidity for the ABSs. It also
includes specific criteria on SME ABS.
Prudential reforms could also help to revive securitisation activity. A key initiative in this field
is the so called Solvency II Directive for the insurance sector, which aims to align capital
requirements with risks that insurance companies have actually taken in their investing
activities. In the current proposal for Solvency II, which will probably come into force on
1 January 2016 with a 10-year phase-in period, the capital requirements for certain
securitised products will increase significantly, thus potentially reducing insurers' willingness
to allocate funds to such asset classes. The appropriateness of the capital charges in
Solvency II and their consistency with the capital requirement rules under the CRD IV are
currently being reviewed by EIOPA. In this regard, particular attention needs to be paid to
providing a level playing field for banks and insurers as well as to enhancing long-term
financing of the real economy through the securitisation of debt.
Conclusion
In the nearer term, how can the impediments to bank funding of SMEs be addressed? In
essence, these impediments are of three types: the banks' own funding conditions, their
perception of the credit risk of their clients, and lack of capital. The ECB does not have a
magic wand. The central bank cannot compensate for a shortage, or a misallocation of
equity. That is something that has to be addressed, in one form or the other, by other
stakeholders. Neither can the central bank alter the credit risk of individual borrowers,
although governments can have an impact here through reforms that improve the operating
environment of those firms - labour and product market regulation for instance. Where the
central bank has a direct role, within its mandate, is primarily with respect to bank funding
conditions. Indeed, the ECB has taken and will continue to take appropriate measures to
ensure that bank funding is not a source of financial fragmentation or an impediment to bank
lending. It is reasonable to think that simultaneous action on all three counts, by the relevant
stakeholders in each case, would be mutually reinforcing.
BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches