Communication from the Commission to the Council and the European Parliament - Access to finance of small and medium-sized enterprises
Date: 2003-12-01
Institutions: European Commission
Subjects: EU Member State, EU financial instrument, accession to the European Union, corporate finance, credit, financial instrument, small and medium-sized enterprises, third country

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 1.12.2003
COM(2003) 713 final

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL
AND THE EUROPEAN PARLIAMENT

Access to finance of small and medium-sized enterprises

1.

2.

3.

3.1.

3.2.

3.3.

3.4.

4.

4.1.

4.2.

4.3.

4.4.

4.5.

4.6.

4.7.

5.

5.1.

5.2.

5.3.

6.

6.1.

6.2.

6.3.

TABLE OF CONTENTS

Executive summary.................................................................................................... 3

Council request........................................................................................................... 4

Financial instruments supporting SMEs ................................................................. 5

Financial instruments of the EU................................................................................... 5

Member States.............................................................................................................. 6

Accession and candidate countries............................................................................... 6

Policy framework ......................................................................................................... 7

Bank lending............................................................................................................... 8

Code of conduct ........................................................................................................... 8

Microlending................................................................................................................ 8

Measuring SMEs’ access to finance .......................................................................... 10

Rating of SMEs .......................................................................................................... 10

Guarantee instruments................................................................................................ 12

EIF activities .............................................................................................................. 12

EIB global loans......................................................................................................... 14

Equity finance........................................................................................................... 15

Market failures in risk capital .................................................................................... 15

Good practices in training .......................................................................................... 16

Increasing the liquidity of capital markets ................................................................. 17

Conclusions ............................................................................................................... 18

Improving framework conditions............................................................................... 18

Focusing on early-stage finance, in particular guarantees and microlending ............ 18

Increasing equity ........................................................................................................ 19

ANNEX Overview of recent national actions in SME finance.................................. 21

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1.  EXECUTIVE SUMMARY

Improving access to finance is an important aspect of fostering entrepreneurship in Europe.
The  role  of  the  public  sector  should  primarily  be  to  improve  the  general  framework
conditions  of  finance  and  take  limited  direct  action  only  when  market  failures  warrant  it.
Experience has shown that best results in SME finance are achieved when the public sector
works with the markets and acts as a catalyst to encourage their development.

Financial instruments. The problems of finance facing start-up businesses require long-term
solutions involving the public sector. Most Member States have programmes and institutions
that  aim  to  overcome  the  gap  in  early-stage  SME  finance  caused  by  high  risk  and  high
overhead costs. Efficient public support mechanisms need to be tailored to local conditions
and need to be simple and accessible. This can only be achieved by using local banks and
venture  capital  funds  as  intermediaries  –  as  happens  with  the  Community  financial
instruments.

Bank lending. Experience from the EU financial instruments shows that loan guarantees are
a very efficient way to use limited public funds and directly address the problems of lacking
collateral and intangible assets. To improve the conditions of bank lending, the Commission
has facilitated discussions about a code of conduct for  credit  institutions and  SMEs.  It  has
also  produced  a  report  on  best  practices  in  microlending.  The  Community  financing
institutions, the European Investment Bank (EIB) and the European Investment Fund (EIF)
provide important support to SMEs’ access to finance.

The increasing risk awareness of banks has led them to expand the use of internal rating of
SMEs,  which  will  gradually  lead  to  a  rating  culture  where  SMEs  need  to  signal  their
creditworthiness  to  the  banks,  regularly  discuss  their  credit  standing  and  deliver  timely
information.

Equity finance. Many SMEs need stronger balance sheets although formal venture capital is
an  option  only  for  entrepreneurial  growth  companies.  In  addition  to  developing  European
venture capital markets, promoting the possibilities provided by business angels and business
angel networks should continue to receive attention at regional, national and European level.

The proposed new capital requirements for banks from 2007 onwards will increase stability
and competition in European financial services markets, and they should also bring benefits
to the SME sector. The effects of the new rules for the European economy, and in particular
for SMEs, are the subject of a study being carried out on behalf of the Commission.

Conclusions. To efficiently promote entrepreneurship in Europe, further European, national
and  regional  public  sector  actions  should  be  focused  on  three  areas  of  SME  finance:  (1)
improving  the  framework  conditions;  (2)  focusing  on  early-stage  financing,  in  particular
guarantees and microlending; and (3) increasing equity in SME balance sheets.

(cid:1)  Improving  the  framework  conditions.  Besides  completing  the  single  market  and
removing  obstacles  from  growth,  developing  financial  markets  will  be  a  particular
challenge  in  the  accession  countries  because  they  suffer  from  low  level  of  equity
investments  and  bank  lending. These  countries  merit  special  attention,  as  otherwise  the
underperforming financial markets will hamper entrepreneurship and growth.

(cid:1)  Focusing  on  early-stage  finance,  in  particular  guarantees  and  microlending.  The
persistent gap in early stage finance makes it necessary that the public sector continues to
work  with  the  private  sector  to  overcome  it.  Easily  and  widely  available  guarantee
instruments  that  share  risk  between  the  private  and  public  sectors  effectively  address
SMEs’  difficulties  in  getting  bank  loans.  Microlending  can  provide  start-ups  with  a

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decisive  help  and  loan  guarantees  should  be  used  efficiently  to  promote  it.  The  use  of
national financial intermediaries and national programmes makes it possible for financial
instruments  to  be  tailored  to  the  different  financing  traditions  providing  additional
leverage to programmes targeted at the financing gap in early stage SME finance.

(cid:1)  Increasing equity. The needs of entrepreneurial growth companies and the  mainstream
European SMEs are different, but both need stronger balance sheets with enough equity.
Retained  earnings  are  the  best  form  of  financing  growth  and  investment.  The  Member
States  should  review  whether  their  tax  laws  inhibit  firm  growth  by  taxing  retained
earnings more than distributed profits. For entrepreneurial growth companies, liquid and
well-functioning venture capital markets are essential.

2.  COUNCIL REQUEST

In  its  meeting  on  4  and  5  December  2001  the  Energy  and  Industry  Council  approved
conclusions on small and medium-sized businesses’ (SMEs’) access to finance and  invited
the Commission to submit an initial assessment of progress in 2003. The conclusions were
partially addressed to the European Investment Fund (EIF), the European Investment Bank
(EIB), and to the countries participating in the Multiannual Programme for Enterprises and
Entrepreneurship (2001-2005).

The Council invited the Commission to:

(cid:1)  Encourage  professionalism  of  the  various  players  in  the  field  of  equity  finance  by

identifying good practices in the field of public and private training;

(cid:1)  Facilitate contacts between banks, other financial providers and SMEs in order to draft a
European  code  of  conduct  between  banks  and  SMEs  and  thus  strengthen  their
understanding of each other, and determine best practices for reducing the complexity of
the administrative procedures involved in financing or government guarantees;

(cid:1)  Measure on a regular basis SMEs' access to finance;

(cid:1)  Explore  ways  of  reducing  the  informational  asymmetries  between  capital  supply  and
demand,  looking  in  particular  at  risk  assessment  methodologies  that  are  accessible,
transparent and suited to SMEs' requirements;

(cid:1)  Explore ways to increase liquidity of capital markets;

(cid:1)  Submit an initial assessment of progress in 2003;

In particular, the Council called on the European Investment Bank (EIB) to direct its global
loans more towards segments where market failures are significant and to make sure that the
EIB’s financing efforts have an impact at the level of SMEs as well.

The Council invited the Commission and the European Investment Fund (EIF) to:

(cid:1)  Conduct an analysis in the field of risk sharing schemes between the private and public
sectors,  with  particular  reference  to  guarantee  systems  and  the  various  forms  of
securitisation;

(cid:1)  Reflect upon the setting up of a guarantee system that facilitates fund raising and creates a
significant multiplier effect for  private  investment  sources  (banks,  risk  capital,  business
angels) consistent with state aid rules;

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(cid:1)  Focus action concerning risk capital on segments where market failures are most evident.

The  Council  called  the  Member  States  to  give  priority  to  initiatives  related  to  access  to
finance,  such  as  actions  promoting  entrepreneurship,  good  practices  in  the  financial
management and quality financial information concerning SMEs; and to encourage contacts
between  banks,  other  finance  providers  and  SMEs  in  order  to  improve  their  mutual
understanding.

3.  FINANCIAL INSTRUMENTS SUPPORTING SMES

3.1.  Financial instruments of the EU

financial 

instruments  of 

the  Multiannual  programme 

for  enterprises  and
The 
entrepreneurship  (2001-2005)  provide  European  leverage  and  support  for  SME  financing.
These  instruments  are  implemented  by  the  European  Investment  Fund  (EIF),  which  is  the
risk  finance  arm  of  the  European  Investment  Bank  (EIB).  Furthermore,  the  European
Regional Development Fund has allocated €1.5 billion to SME development in the Member
States for the period 2000-2006.

The  SME  Guarantee  Facility  provides  guarantees  for  guarantee  schemes  and  financial
institutions  within the public and  private  sector  that support  lending  to  SMEs. The  facility
includes  micro-credit  guarantees,  equity  guarantees,  and  guarantees  for  loans  financing  IT
equipment,  software  and  training.  The  SME  Guarantee  Facility  has  proved  to  be  a  very
effective tool and since 1998 it has benefited more than 125 000 SMEs in a wide range of
sectors. More than 90% of enterprises benefiting from loan guarantees are microenterprises
with fewer than 10 employees and their job creation has increased significantly1. About 45%
of beneficiaries are start-up firms.

The  latest  yearly  report  on  the  financial  instruments  indicated  that  the  guarantee  facility
made  possible  lending  to  SMEs  that  is  58  times  the  budgetary  spending,  which  is  an
extremely efficient use of EU funds2.

The  ETF  Start-up  Scheme  supports  the  financing  of  SMEs  in  their  start-up  phase  by
investing in venture capital funds and business incubators. The funds should in particular be
seed funds, smaller funds, funds operating regionally or funds focused on specific sectors or
technologies, or venture capital funds financing the exploitation of R&D results. EIF invests
usually about 15 % in the capital of a new venture fund and the rest of the investment must
be  raised  from  other  sources,  although  under  the  current  unfavourable  market  conditions
very  few  new  funds  have  been  successfully  set  up.  The  ETF  Start-up  mostly  benefits
entrepreneurial growth companies in an innovative technology or service area.

The ETF Start-up Scheme in an effective instrument that has increased the supply of venture
capital to SMEs, particularly in the early stages of development and in the high technology
sectors  where  there  is  an  identified  market  failure.  So  far,  more  than  200  companies  with
high  growth  potential  have  benefited.  The  ETF  Start-up  has  had  a  significant  impact  on
growth and employment, and a further positive influence on job creation is foreseen over the
next few years, particularly in information technology, biotechnology and life sciences. The
structure  of  the  scheme,  using  co-investments  by  EIF  in  venture  capital  funds,  has  been
deemed to be an efficient way of making larger amounts available to final beneficiaries and
an  efficient  use  of  Community  resources.  The  use  of  national  financial  intermediaries  and

1

2

See  the  report  “Measures  on  financial  assistance  for  innovative  and  job  creating  small  and  medium-
sized enterprises”, COM(2003) 480 final, 5.8.2003.
The budgetary resources were €155.7m, which allowed guaranteeing loans worth of €9.02bn.

5

                                                
national programmes  make it possible for the Community instruments to be tailored to the
different financing traditions and market circumstances of the participating countries.

The Seed Capital Action provides support for the long-term recruitment of new investment
managers  to  reinforce  the  capacity  of  seed  funds.  The  grants  are  aimed  at  covering
management  costs  of  hiring  in  new  funds  or  incubators  that  include  seed  capital  in  their
global investment programme. However, as few new funds have been set up for seed capital,
there has been little demand for this instrument.

The persistence of the gap in early-stage SME finance and the good experiences gained from
the financial instruments, in particular from the SME Guarantee Facility, speak for the need
to continue to provide such instruments also in the future. With regard to the ETF Start-up
Scheme,  companies  with  growth  potential  will  be  the  ones  to  provide  employment  and
growth in the future and the catalytic role of the public sector activities in their early-stage
venture finance continues to be essential.

3.2.  Member States

Most  Member  States  have  programmes  supporting  SMEs’  access  to  finance3.  In  order  to
establish  best  practices  and  to  find  out  the  most  efficient  leverage  achievable  for  limited
public funds, evaluations of SME support programmes provide important information. As an
example,  the  evaluation4  of  the  Finnish  Industry  Investment  venture  capital  programmes
urged  clearer  focus  on  market  failures,  concentration  on  working  through  financial
intermediaries,  and  a  coordination  of  policies  with  other  agencies.  Comparable  efforts  of
consolidating and simplifying the financial instruments are going on eg. in Germany where
the KfW-Mittelstandsbank is taking over and streamlining instruments targeted at SMEs.

One way to facilitate  SMEs’ access to  venture capital is  to  set  up  US-style  small  business
investment  companies.  Under  this  scheme,  government  guarantees  allow  investment
companies  to  borrow  money  at  low  rates  on  the  capital  markets.  Together  with  privately
raised  capital  the  money  is  then  invested  in  SMEs.  Although  these  investment  companies
that benefited from public guarantees made only 11% of the total amount of US early-stage
venture capital investments in 2002, it was almost 60% of the total number of deals. Several
of the existing promotional SME banks in the Member States function in a way comparable
to the small business investment company scheme, including KfW in Germany, Finnvera in
Finland  and  BDPME  in  France.  Furthermore,  both  United  Kingdom  and  Belgium  are
looking  at  the  possibilities  of  having  a  programme  comparable  to  the  small  business
investment  company  scheme.  The  UK  programme  would  give  funds  favourable-rate
government loans to complement their private financing. Paying back these loans could be
deferred until cash flows from the investments materialise and the government would get a
proportion of the profits5.

The flexibility of the European Union financial instruments can provide additional leverage
to a variety of national SME financing programmes, including new initiatives as described
above.

3.3.  Accession and candidate countries

The  financial  systems  of  the  accession  and  candidate  countries  supply  less  equity
investments  and  bank  lending  than  in  the  current  Member  States.  The  average  ratio  of

3

4

5

See the annex of this report.
M.  Maula  and  G.  Murray:  Finnish  Industry  Investment  Ltd.  An  International  Evaluation.  Kauppa-  ja
teollisuusministeriö, 2003.
Bridging  the  finance  gap:  a  consultation  on  improving  access  to  growth  capital  for  small  businesses,
HM Treasury, April 2003.

6

                                                
domestic  bank  lending  to  GDP  in  the  accession  countries  is  around  40  %,  whereas  the
average for the euro area is 140 %6. Small firms suffer most from underdeveloped financial
and legal systems, including unclear bankruptcy laws. In particular, if corporate performance
is not transparent and creditor rights are weak, collateral-based lending is not attractive for
banks. Weak legal protection also discourages the use of trade credit and long-term lending,
which is at a low level in the accession and candidate countries7.

Credit constraints limit the growth of SMEs in most accession and candidate countries, but
there are differences. In countries that have a business environment favourable to financing,
also  the  SME  sector  is  numerically  stronger.  Furthermore,  foreign  bank  penetration  has
improved financing conditions for all firms, including SMEs.

Venture capital markets in the accession and candidate countries suffer from the weak and
illiquid stock markets that limit investors’ exit possibilities and the preferred exit option of
venture  capital  funds  in  these  countries  is  to  find  foreign  strategic  investors.  The  venture
capital  investments  have  concentrated  on  later  stage  investments,  mature  enterprises  and
low-tech  companies8.  The  countries  lack  high-tech  entrepreneurship,  but  the  foreign-
dominated  and  young  venture  capital  industry  might  also  lack  the  means  like  local
knowledge  and  informal  networks  to  find  potential  entrepreneurs.  Furthermore,  there  are
administrative  and  cultural  barriers  to  entrepreneurship  emanating  from  universities  and
research institutions and links between them and businesses are weak.

Overall,  the  accession  and  candidate  countries  need  to  pay  attention  to  the  further
development  of  their  financial  systems.  This  includes  capacity  building  throughout  the
financial sector making it easier for banks to become more acquainted with SMEs and more
willing to provide medium and long-term lending. Furthermore, a gradual emergence of an
equity culture will open the way for a more developed venture capital industry.

Since 1999 the European Commission has been supporting capacity building in the financial
markets of the accession and candidate countries through the SME Finance Facility, which
has been funded by the Phare and Meda programmes. This facility has been managed by the
European  Bank  for  Reconstruction  and  Development,  the  Council  of  Europe  Bank  in
cooperation with the KfW, and by the EIB, which have offered credit lines to local banks for
SME  lending.  These  banks  have  also  received  financial  incentives  to  train  their  personnel
and to lend to SMEs.

The  adoption  of  the  body  of  European  Union  legislation  and  the  implementation  of  the
Financial  Services  Action  Plan  will  help  the  accession  and  candidate  countries  to  solidify
their legal environment, which will facilitate the development of financial markets.

3.4.  Policy framework

The problems of finance facing start-up businesses are to a large extent structural and require
long-term solutions involving the  public sector. The  US  experience  shows  that  even  under
very favourable conditions early-stage venture capital investments continue to be dependent
on  the  participation  of  the  public  sector.  However,  the  role  of  the  public  sector  should  be
seen  as  a  facilitator  and  catalyst  rather  than  provider  of  ready-made  solutions.  The
experience of many Member States has shown that risk sharing between public and private
sectors in a partnership between banks and SME development institutions is an efficient way
of alleviating finance problems facing SMEs.

6

7

8

Financial Sectors in EU Accession Countries, ECB, 2002.
L.  Klapper,  V.  Sarria-Allende  and  V.  Sulla:  Small  and  Medium-Size  Enterprise  Financing  in  Eastern
Europe. World Bank, 2002.
I.  Iliev:  Barriers  to  Venture  Capital  Investment  in  Innovative  SMEs  in  CEEs  –  Causes  and  policy
Implications. Annual Anglo-Polish SSEES Colloquium, London, 2003.

7

                                                
Simplicity and accessibility of support mechanisms must be one of the overriding goals of
SME  policy.  The  consistent  message  from  entrepreneurs  is  that  their  key  task  is  to  run  a
business,  not  to  deal  with  bureaucracies.  They  do  not  have  time  for  targeted  specific
programmes that require heavy procedures and long processing times. From the beneficiary
viewpoint,  the  simplicity  of  dealing  with  their  habitual  bank  (or  venture  capital  fund)  but
getting the benefit of local, regional, national or European public participation is valuable.

The need to promote entrepreneurship on a wide front, taking on board both entrepreneurial
growth  companies  and  mainstream  SMEs,  requires  financial  instruments  that  are  defined
broadly enough so that they can be used for various purposes according to changing market
needs, like financing second chance entrepreneurship or transfers of businesses.

The  limited  public  funds  available  for  improving  SMEs’  access  to  finance  should  aim  at
maximum efficiency in both the Member States and accession countries. The aim should be
to develop markets and work in partnership with the private sector to achieve high leverage.
European  actions  should  complement  and  support  national  and  regional  efforts  to  develop
early-stage finance. The accession countries pose a particular challenge, as such national and
regional efforts are very recent and in the early phase of operations.

4.  BANK LENDING

4.1.  Code of conduct

The  Council  invited  the  Commission  to  facilitate  contacts  between  banks,  other  financial
providers and SMEs in order to draft a European code of conduct between banks and SMEs.
The  aim  is  to  strengthen  their  mutual  understanding,  and  to  determine  best  practices  for
reducing  the  complexity  of  administrative  procedures  when  applying  for  a  loan  or  a
guarantee.

In  September  2002  the  Commission  invited  a  high-level  expert  group  from  the  banking
sector and from SME organisations to explore the possibilities of setting up such a code. The
group agreed on a compromise text, which was submitted to the national banking and SME
organisations for comments. By the end of October 2003, four organisations had confirmed
their willingness to endorse the resulting European Code of Conduct for Credit Institutions
and  SMEs.  These  were  Eurochambres,  UEAPME,  UNICE  and  the  European  Group  of
Savings  banks,  which  is  one  of  the  main  providers  of  loans  to  SMEs.  The  European
Association  of  Cooperative  Banks  and  the  banking  Federation  of  the  European  Union  had
requested additional time for consulting their national  members. The  Commission  seeks  to
finalise the discussions with the European banking and SME organisations on the code soon.

4.2.  Microlending

The  use  and  importance  of  microloans  (up  to  €25 000)  and  microlending  programmes  has
increased  in  Europe  and  the  Commission  has  produced  a  report  on  best  practices  in
microlending9  based  on  the  work  of  an  expert  group.  The  group  reviewed  microlending
programmes  in  Europe  aiming  to  find  good  practices  that  supported  enterprise  creation.  It
also sought examples of national programmes developing cooperation between promotional
SME  financing  institutions  and  local  banks,  looked  at  the  role  of  guarantee  schemes  in
microlending, and reviewed the leverage achieved by establishing partnerships with business
support services.

9

“Microcredit for small businesses and business creation: bridging a market gap”, Enterprise Directorate-
General, 2003.

8

                                                
The report concluded that insufficient supply of microloans is a major issue when business
creators  are  unemployed  persons,  women  or  belong  to  ethnic  minorities.  Supporting  the
supply  of  microloans  is  therefore  not  only  an  issue  of  entrepreneurship  and  economic
growth, but also of social inclusion.

Banks often look at microcredit as a high risk and low return activity due to the high failure
rate  and  overhead  costs.  Although  the  situation  varies  between  the  Member  States,  banks
usually  are  not  active  enough  in  microlending.  In  the  majority  of  accession  and  candidate
countries credit supply constrains business creating and the growth of SMEs.

Most  countries  recognise  the  need  for  public  support  for  microcredit  and  provide  such
support.  However,  further  measures  are  necessary  to  overcome  the  market  gap.  These
measures should concentrate on creating a favourable regulatory and fiscal environment for
investors  supplying  funds  to  microcredit  institutions.  Other  actions  could  support  lending
programmes  aimed  at  microfinance  institutions,  sharing  risk  with  guarantee  societies  and
promoting business support services.

Guarantee  schemes  enable  banks  to  provide  microcredits  because  both  the  risk  and  the
capital requirements are lower. Publicly owned promotional SME banks are an efficient way
to provide loans and loan guarantees because they can use local banks to lend further to SME
borrowers.  Public  sector  instruments  can  have  both  credit  and  guarantee  components,  or
microloans  can  be  provided  without  collateral.  At  the  European  level,  the  Multiannual
programme  has  a  special  microcredit  guarantee  window  that  has  helped  to  set  up  several
guarantee schemes in the Member States.

Although  the  main  barrier  for  start-ups  and  small  businesses  is  access  to  finance,  not  the
interest  rate,  some  countries  still  provide  microloans  with  a  subsidised  rate.  In  an
environment  where  interest  rates  are  very  low,  subsidised  interest  rates  are  irrelevant.  A
more  market  driven  approach  would  allow  lending  costs  to  be  covered  and  would  make
private microlending industry at least potentially self-sustainable. It should also be noted that
the practice of setting usury rate, ie. ceiling for acceptable interest rate, makes it impossible
for financial institutions to provide financing to risky start-ups. This can also be a barrier to
entrepreneurship and self-sustainability of the private microcredit industry.

In  order  to  strengthen  European  and  national  partnerships  in  microfinance,  the  report
recommended that the EU should increase the budget of the SME Guarantee Facility of the
MAP, in particular the microcredit window. The European Regional Development Fund and
European  Social  Fund  should  also  be  used  to  promote  microcredit  activities  based  on
existing good practices, in particular in accession and candidate countries.

The report recommended that the Member States should improve their legal framework and
financial  environment  to  make  it  easier  for  microlending  institutions  to  raise  funds  and
provide  microloans  for  start-ups  and  small  enterprises.  Because  the  microcredit  industry
should aim for self-sustainability, the level of public support should gradually decrease and it
should  be  carefully  adapted  to  the  targeted  businesses.  The  Member  States  should  also
encourage  co-operation  between  microfinance  institutions  and  business  support  service
providers.

In the interests of high performance and good governance, the report encouraged microcredit
institutions  to  assess  and  monitor  their  performance  with  clear  targets.  They  should  also
exchange views on the quality of credit decisions and the adequacy of reserve policies. The
industry also needs clear risk management procedures.

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4.3.  Measuring SMEs’ access to finance

The Council invited the Commission to measure on a regular basis SMEs' access to finance.
This request refers to the problem that the shortcomings of comparable national statistics do
not  allow  the  development  of  a  coherent  picture  of  developments  in  SME  financing  at
European  level.  This  problem  has  already  been  alleviated  by  the  European  Central  Bank,
which  started  in  April  2003  a  quarterly  survey  of  bank  lending  to  the  private  sector.  This
survey seeks to answer some of the questions about bank lending to firms, including SMEs.
The European SME Observatory also regularly reports on SME financing questions.

The European Commission has updated its recommendation on the SME definition10, which
will come  into force in  2005,  and  will  contribute  to  the  clarity  and  comparability  of  SME
statistics. The Commission will continue to review the availability of data on SME finance
conditions.

4.4.  Rating of SMEs

The Council invited the Commission to explore ways to reduce the information asymmetries
between capital supply and demand, looking in particular at risk assessment methodologies
that are accessible, transparent and suited to SMEs’ requirements.

This invitation  stemmed,  among  other reasons,  from  the  ongoing  changes  in  the  European
banking  system,  in  particular  the  proposed  introduction  of  new  capital  adequacy  rules  for
banks (the Basel II process)11.

The new capital  requirement  rules  are  designed to  increase  the  soundness  of  the  European
banking system. They aim to align the calculation of regulatory capital charges more closely
with  banks’  own  economic  processes  and  risk  assessments,  and  they  will  bring  increased
stability and competition to European financial services markets. As such they should confer
positive benefits on the SME sector and European industry as a whole.

During the negotiating process much attention has been paid to direct effects of the proposal
on banks’ SME lending. The July 2003 discussion document proposed parameters that would
not put SMEs in a disadvantaged position against other bank clients. A study of the potential
impact of the new rules carried out by the Basel Committee and the European Commission
indicated  that  the  regulatory  capital  requirements  for  lending  to  SMEs  will  be  lower  than
under current rules.

However,  the  proposed  rules  have  other  effects  on  SME  finance.  Three  are  particularly
important:  the  emerging  rating  culture  of  SMEs,  the  venture  capital  investments  of  banks,
and the securitisation of SME lending by banks.

While banks are generally expected to have sound risk management in place and to assess
the  risk  of  customers  properly,  the  new  capital  requirement  rules  will  support  the
improvement  of  banks’  risk  management,  measurement  and  control.  The  increase  in  risk
awareness of banks can lead to an expanded use of banks’ internal rating systems which may
influence banks’ information requirements concerning their SME customers.

A  goal  of  internal  rating  systems  is  to  make  loan  pricing  reflect  more  accurately  firm
riskiness: stable and profitable companies will pay less, riskier ones will pay more. A sound
risk  assessment  requires  that  SMEs  provide  information  about  their  current  situation  and

10

11

Recommendation no 2003/361/EC, OJ L 124 of 20.5.2003.
Review  of  capital  requirements  for  banks  and  investment  firms.  Commission  services  consultation
papers, 22 November 1999, 5 February 2001, 1 July 2003.

10

                                                
future prospects so that the banks can make a rating. In the long run the information requests
will lead to a rating culture where SMEs perform  structured  business  analysis and  provide
the banks with revenue and production forecasts, sector prospects, management succession
plans,  and  other  information.  Banks  will  decide  on  the  level  of  sophistication  required  of
their  rating  systems  balancing  their  complexity,  feasibility  and  costs.  Information
requirements  should  be  proportionate  taking  into  account  the  size  of  exposure  and  the
riskiness of the borrower.

The  rating  culture  should  be  based  on  structured  analysis,  openness  and  communication.
SMEs have to signal their creditworthiness, document their economic situation, present their
planning  concepts  and  balance  sheets,  regularly  discuss  credit  standing  and  deliver  timely
information  to  the  banks.  For  technology  intensive  companies,  the  rating  system  should
include  technology  risk  assessment  (technology  rating12)  to  enable  potential  investors  to
appraise  the  risks  and  rewards  of  investments  in  technology  projects.  By  enabling
companies’ technology projects to be rated according to risk and reward, technology rating
can increase confidence in the viability of such companies. Based on reviews of technology-
rating tools, the Commission will, in cooperation with SMEs and financial institutions, look
at ways to promote the use of such tools.

The Commission has organised several meetings of an expert group on the rating of SMEs to
review  how  changes  in  bank  behaviour  are  influencing  bank  lending  to  SMEs.  Banks  are
anticipating  the  likely  changes  brought  by  the  proposed  new  capital  requirements.  Such
changes  include  the  differentiation  of  SMEs’  loan  costs  according  to  risk.  Banks’  capital
requirements  are  only  one  factor  affecting  the  new  environment,  and  the  expert  group  has
also noted other changes in finance environment like new technologies, globalisation and the
convergence of all financial services. Banks are increasingly competing internationally and
only those that are solidly profitable can stay in the game in the long run.

From the point of an SME, the information requirements of banks and venture capitalists are
becoming more similar and all enterprises need to pay increasing attention to their investor
relations. The objectives, strategic plans and expected developments of the firm need to be
presented to investors clearly and transparently in order to build long-term confidence in the
company  and  its  management.  SMEs  need  tools  and  capabilities  for  planning  and  dealing
with banks.

The Commission is working on establishing frameworks and spreading good practices that
help firms  in  the  new financial environment. To  help  companies  in  presenting  comparable
and  reliable  information,  all  listed  companies  will  use  International  Accounting  Standards
and International Financial Reporting Standards from 2005 onwards13. The gradual adoption
of  these  standards  by  SMEs  will  increase  transparency  and  make  it  easier  for  banks  and
investors across borders to understand the information presented and to make comparisons.
The Commission’s Communication on enhancing corporate governance14 sets the framework
for further action in this area.

To  provide  practical  advice  on  how  to  deal  with  banks,  the  Commission  is  launching  two
actions  that  will  take  place  in  2004  in  the  countries  participating  in  the  Multiannual
programme. The first action is to draft a guide for SMEs on how to deal with banks and how
to provide the information that the banks need in a rating environment. The second action is
a series of seminars for SMEs and their organisations on the same subject.

12

13

14

See the Communication on investing in research, COM(2003)226, 30.4.2003.
Regulation EC 1606/2002, OJ L243, 11.9.2002.
COM(2003)284, 21.5.2003.

11

                                                
In  conclusion,  the  continued  improvement  of  banks’  rating  systems  has  the  potential  to
change the relationship between SMEs and banks. On one hand, rating systems will lead to
an increasing price differentiation according to customer risk. On the other hand, banks will
be  able  to  process  loan  requests  quickly  and  adopt  a  more  structured  approach  to  loan
approvals. Consequently, banks would be in the position to communicate the results of their
risk  assessment  to  clients,  and  clients  could  use  it  as  a  starting  point  in  improving  their
business strategy.

4.5.  Guarantee instruments

The Council invited EIF to conduct an analysis in the field of risk-sharing schemes, and to
reflect  upon  the  setting-up  of  a  guarantee  system  that  facilitates  fund  raising.  Loan
guarantees allow the sharing of the borrower’s credit risk between the lending bank and the
guarantor.

As a part of preparing this report, all countries participating in the Multiannual Programme
were invited to provide information about new risk sharing schemes. The results presented in
the  annex show  Member  States  are  very  active  in  this  field  and  some  are  developing  new
innovative  ways  of  expanding  their  programmes.  Thus  there  is  a  wide  agreement  on  the
benefits of loan guarantees, as they can give financial institutions incentives to lend to risky
SMEs.  Guarantee  instruments  are  also  a  very  efficient  way  to  use  limited  public  funds  to
achieve  a  high  leverage  effect  and  guarantee  activities  can  be  expanded  through  increased
awareness at national and regional level.

The Commission launched in autumn 2003 a benchmarking project on guarantees to increase
their visibility and to establish best practices. The project will carry out a survey of national
administrations and guarantee institutions in order to establish the extent to which guarantee
schemes are currently being used. The results of the survey will be used as a starting point
for discussions in an expert group and the results of the survey and the discussions will be
presented in a final report outlining the advantages and disadvantages of guarantee schemes.

It is necessary that all publicly supported guarantee schemes are consistent with the State aid
rules laid down in the EC Treaty15 and in particular with the Commission notice on State aid
to guarantee schemes16. Under this notice guarantees must be linked to a specific  financial
transaction undertaken by SMEs and must not cover more than 80% of the amount of each
outstanding  loan,  and  may  not  be  granted  to  SMEs  in  financial  difficulty.  The  terms  of  a
guarantee  scheme  must  be  based  on  a  risk  assessment  for  granting  the  guarantee  and  the
premiums must reflect such risk as well as the administrative costs of the scheme. The State
aid  rules  give  the  Commission  the  power  to  assess  guarantee  schemes  and  it  must  grant
authorisation  before  such  schemes  can  be  implemented.  However,  SME-oriented  schemes
where the aid amounts involved are small (less than €100 000 over a three-year period) are
exempt from the authorisation requirement17.

4.6.  EIF activities

The  purpose  of  EIF’s  guarantee  products  is  to  provide  effective  support  for  SMEs  by
increasing the volume of bank lending to SMEs. Guarantees are particularly attractive in this
respect for the public sector because they provide high leverage for public funds as lending

15

16

17

The State aid rules are laid down in Articles 87-89 of the EC Treaty.
Commission notice on the application of Articles 87 and 88 of the EC Treaty to State aid in the form of
guarantees, OJ C71, 11.03.2000, p. 14.
Commission Regulation (EC) No 69/2001 on the application of Articles 87 and 88 of the EC Treaty to
de minimis aid, OJ L10, 13.01.2001, p. 30.

12

                                                
can  be  expanded  substantially  through  relatively  small  guarantee  amounts.  The  lending
banks also benefit from lower regulatory and economic capital.

EIF’s  status  as  a  AAA-rated  multilateral  institution  allows  its  financial  intermediaries  to
have:

(cid:1)  Lower regulatory capital on assets guaranteed by the EIF;

(cid:1)  Expanded lending capacity and improved return on equity in their SME operations;

(cid:1)  Easier risk transfer to third party investors;

(cid:1)  Easier credit risk transfer to the capital markets through bond issuance guaranteed by EIF.

EIF  addresses  market  failures  and  supports  SME  lending  by  managing  programmes  on
behalf  of  the  European  Commission.  These  are  called  the  EIF  trust  activities.  The  EIF’s
operations  involving  its  own  resources  and  risk,  on  the  other  hand,  are  always  on  a
commercial basis, aiming at an adequate risk-adjusted return on equity for the Fund.

EIF  intends  to  focus  the  SME  Guarantee  Facility  activities  on  new  markets  and
intermediaries, in particular in the accession countries, while extending its cooperation with
current intermediaries in the European Union.

The  key  success factor  in  the  implementation  of the  SME  Guarantee  Facility  has  been the
ability  to  work  with  well-functioning  existing  programmes  by  adapting  the  Facility
requirements  to  the  specific  market  characteristics  without  imposing  a  fixed  structure
throughout the Union.

Likewise,  EIF  will  seek  cooperation  with  a  wide  range  of  financial  institutions  in  the
accession countries, including commercial banks, guarantee schemes, promotional banks and
microcredit institutions. The possibility of cooperation with development banks and the EIF
bank shareholders is currently being explored.

At  the same  time,  EIF  works  in  close  cooperation  with  the  services  of  the  Commission  to
develop  new  programmes,  as  to  ensure  continuity  in  the  availability  of  the  European
Community  guarantee  facilities.  In  this  context,  in  addition  to  the  existing  guarantee
products  of  the  Multiannual  Programme,  a  wider  use  of  products  enhancing  loan
securitisation could be explored because these  products  present  high  added  value  and  high
leverage effect on the available resources.

The EIF guarantees have developed from straightforward portfolio guarantees towards more
sophisticated products such as credit default swaps and financial guarantees on asset-backed
securities.  This  development  is  likely  to  continue,  with  a  further  shift  towards  structured
finance transactions, which fit well with the limited underwriting capacity of the EIF. These
transactions  allow  to  transfer  credit  risk  on  large  portfolios  with  limited  guarantee
commitments from EIF. It can therefore underwrite target risk profiles comparable or better
than those covered in credit insurance transactions and achieve a much better diversification
in its overall portfolio.  Credit  enhancement  by  securitisation  has  become  the  main  product
involving EIF’s own risk, representing 74 % of guarantees signed in 2002.

Financial  institutions  will  likely  use  more  securitisation  techniques  to  manage  their
portfolios,  to  diversify  funding  sources  at  attractive  conditions,  as  well  as  to  provide
enhanced financial services to their customers. EIF has conducted a study on securitisation
and  sees  its  main  role  in  securitisation  transactions  in  supporting  SMEs’  access  to  debt
finance by facilitating credit risk transfer from the originating banks to the capital markets.
This is particularly important since the SME securitisation market is still in its early stage in

13

Europe as it is based on heterogeneous assets with a relatively long maturity. EIF also seeks
to stimulate interest in asset-backed financing among stakeholders.

The proposed new capital requirement rules establish a regulatory framework for the capital
treatment  of  banks’  securitisation  exposures.  Banks  will  be  permitted  to  rely  on  rating
agencies  to  calculate  the  level  of  regulatory  capital  that  they  must  hold  against  such
exposures.  This  could  make  a  positive  contribution  to  the  development  of  securitisation
markets in the EU.

4.7.  EIB global loans

The Council invited the European Investment Bank to direct its global loans more towards
segments where market failures are significant and to make sure that EIB’s financing efforts
have an impact at the level of SMEs as well.

Under its statutes, the EIB seeks to enhance lending to SMEs located in less developed areas
of  the  Union  and  regards  the  global  loan  mechanism  as  an  essential  tool  for  channelling
funds to  SMEs.  EIB  is  a  wholesale  provider  of  capital  market  funds,  but  it  reaches  SMEs
through a network of commercial banks.

The main advantage of EIB funding is the medium and long-term nature of the debt, which
helps address some capital market weaknesses. EIB funding is advantageous also because it
is at fine interest rates, thanks largely to EIB’s AAA credit rating. This beneficial impact of
EIB global loans may become even more important in the future, as commercial banks adapt
to  changing  circumstances  and  concentrate  on  their  most  profitable  lines  of  business.  In
some  markets  this  might  imply  a  reduction  in  SME  lending.  In  the  perspective  of
enlargement  of  the  Union,  term  finance  for  SMEs  may  continue  to  be  scarce  in  the  new
Member States, hence the importance of EIB's continuing role in that area.

A  proper  evaluation  of  the  economic  effectiveness  of  global  loans  cannot  be  achieved  if
restricted purely to a microeconomic approach, based on analyses of the SME beneficiaries.
The  most  relevant  aspect  of  global  loans  is  the  structural  supply-side  effect  of  having  a
systemic influence on both availability and pricing of term loans to SMEs. In this context, it
is  important  that  EIB  cooperates  with  many  banking  intermediaries,  including  smaller  and
regional  financial  institutions.  Diversification  of  intermediaries  enhances  competition  by
promoting  the  transfer  of  EIB’s  favourable  lending  terms  to  the  final  beneficiaries  and
contributes to a better coverage of beneficiaries, particularly at regional level.

EIB’s global loans are also targeting specific EU policy objectives such as for SMEs in less
developed  areas,  environmental  improvements  and  energy  saving,  where  the  market
availability of debt may be limited. Such dedicated global loans are often complementary to
or in support of national or regional programmes aiming to address market weaknesses. The
EIB’s  innovation  initiatives18  support  the  target  of  investing  3  %  of  European  GDP  into
research by investing in innovative and R&D oriented SMEs both in the mainstream and in
the high technology sectors. The wider range of instruments and increased funds (€50 billion
for 2003-2013) available for these investments signal the EIB’s  commitment  to  innovation
financing. The EIB network of partner banks using the global loans can be an effective tool
in signalling and in helping to implement EU policy.

In managing its global loans EIB continues to increase the number and spread of its financial
intermediaries. A further policy focus is the increasing use of dedicated or specialised global
loans for EU policy objectives and national and regional initiatives. Apart from facilitating

18

Innovation 2000 Initiative and Innovation 2010 Initiative.

14

                                                
the targeting of global loans at segments where market failures or weaknesses are significant,
this will also increase the visibility and transparency of global loans.

EIB recognises the importance of transparency and draws the attention of intermediaries to
ensuring  that  SME  beneficiaries  are  aware  of  the  EIB  origin  of  the  funds.  Such  SME
awareness contributes to encouraging competition between intermediaries and to improving
the  impact  of  EIB’s  favourable  financial  conditions  at  the  SME  level.  EIB  gives  full
information of its partner banks and other intermediaries on its website.

5.  EQUITY FINANCE

5.1.  Market failures in risk capital

The Council invited EIF to focus action concerning risk capital on segments where market
failures are most evident.

EIF seeks to support the emergence of a truly European venture capital market by providing
appropriate financing to high-growth companies in their start-up, later-stage or development
phases, by investing in early-stage, high-tech, regional and pan-European funds, traditionally
the less developed segments in Europe. About 45% of EIF portfolio is composed of early-
stage investments as opposed to 10% of the total European venture capital investments. EIF
investments  contribute  to  the  development  of  sectors  like  biotechnology,  converging
technologies, new materials, ICT and nanotechnology. EIF aims to react flexibly to market
needs, and to develop innovative financial instruments for achieving Community objectives.

The venture capital portfolio of EIF  continued  to expand  from  €2  billion  in  2001 to  €2.45
billion in 2002 despite the market downturn. EIF has contributed to financing about 15% of
the total number of SMEs  benefiting  from  early-stage  investments in  Europe  since  199719.
The EIB Group is instrumental in closing Europe’s technological and competitiveness gap.

The  EIF  total  portfolio  (including  the  EIF’s  own  funds,  and  the  EIB  and  Commission
mandates) as of 1 September 2003 was:

Portfolio

Number of funds or
intermediaries

Number of SME
beneficiaries

Venture capital

Guarantees

2.5bn

5.5bn

190

118

1800

more than 200 000

The  increasingly  balanced  geographical  spread  of  investments  demonstrates  EIF’s
commitment  to  promoting  investments  in  southern  Europe  and  in  the  accession  and
candidate countries where the risk capital markets are less developed.

EIF has extended its activities towards second round and later-stage financing in order better
to meet market needs. This has reinforced EIF’s presence in the SME financing cycle, which
follows the goal set by the November 2002 Competitiveness Council that stressed the role of
the EIB Group in financing innovation in the difficult market conditions. To counterbalance
and mitigate the higher risk of its venture capital operations, EIF will seek a more balanced
portfolio through investments in mid- and later stage SME-oriented private equity funds.

19

EVCA Yearbook 2003.

15

                                                
A stand-alone advisory unit, independent from EIF’s investment activity, was established in
late 2002 with the aim of providing advice in the field of financial engineering, principally
related  to  SMEs.  The  advisory  service  contracts  state  that  the  provision  of  such  services
should not lead to an EIF involvement as investor or guarantor. The two first contracts were
signed with the Instituto de Fomento de Andalucia (IFA) and the Gouvernement de Wallonie
(Ministry  of  Economic  Affairs).  The  first  was  for  technical  structuring  of  seed  funds  and
microcredit operations and the second dealt with the general SME policy framework.

Although  investments  in  SMEs  focusing  on  innovation  and  R&D  might  require  stronger
participation of the public sector than currently is the case, it is important to point out that
any government-backed action to deal with market failures must comply with the State aid
rules of the treaty and specifically with the Commission communication on risk capital and
State aid20. According to the communication, Member States may adopt measures to provide
or promote risk capital or equity financing to SMEs in their start-up or development phases.
This can happen only provided such financing can be justified, for example, by an equity gap
due  to  investor  risk  aversion,  information  asymmetry,  difficulty  to  assess  risk,  or  high
transaction  costs.  At  the  same  time,  the  communication  aims  to  minimise  distortions  of
competition in the internal market. It requires proportionality between public funds and the
identified market failure, as well as state behaviour comparable to that of a private investor
through  profit-driven  decisions,  the  involvement  of  private  investors  under  the  same
conditions in the provision of risk capital, and appointment of independent management.

5.2.  Good practices in training

The Council invited the Commission to encourage professionalism of the various players in
the  field  of  equity  finance  by  identifying  good  practices  in  the  field  of  public  and  private
training. This is important as venture capital funds provide not only equity capital, but also
managerial skills that are critical for the success of high-tech and knowledge-based start-ups.
This combination of financial and managerial know-how sets high requirements for the staff
of venture capital funds.

The background for the Council’s request is the stock market boom of 1999-2000, when the
prospect of high returns in the venture capital industry attracted fund managers who did not
always  have  enough  experience.  The  investments  made  were  often  short  term  and  the
investors did not have sufficient knowledge about the technologies and market potential of
the supported start-up firms. The subsequent burst of the market bubble has led to a much
more  realistic  operating  environment  and  considerable  consolidation  of  the  industry  has
already taken place and this is likely to continue.

Although  European  financial 
institutions  are  well  staffed  with  qualified  finance
professionals, finding persons that combine finance skills with entrepreneurial  and  specific
sector and  technological  knowledge is  difficult.  One  of  the  strengths  of  the  Silicon  Valley
has been the easy flow of people between high-tech start-ups and venture capital funds. Such
exchange  of  experience  rarely  happens  in  Europe,  although  informed  and  efficient  venture
capital  operations  would  benefit  from  combined  finance/technology  expertise.  In  Europe,
attention  should  focus  on  cooperation  between  venture  capital  funds  and  universities  and
research institutions that can provide expertise on specific areas.

To  increase  expertise  in  finance  an  in  entrepreneurial  and  technical  capabilities,  training
programmes  are  an  alternative.  Such  training  programmes  should  reflect  both the acquired
body  of  knowledge  in  the  industry  and  its  dynamic  and  changing  nature  in  portfolio
management, asset valuation, derivatives  and  quantitative  analysis. The training  courses  of

20

Commission communication on state aid and risk capital, OJ C235, 21.08.2001, p. 3.

16

                                                
EVCA, the European Venture Capital and Private Equity Association, are addressing these
problems.

The  venture  capital  industry  itself  is  the  primary  source  of  information  about  its  training
needs.  Based  on  the  Council  request,  the  Commission  tried  to  launch  a  tender  aiming  to
provide a clear view on existing training structures and to identify the needs of the industry.
However, no offers were received, which indicated a lack of market interest in this topic.

5.3.  Increasing the liquidity of capital markets

The Council invited the Commission to explore ways to increase liquidity of capital markets.
Here, the primary task at European level is to establish a stable and harmonised framework
of laws and regulations that allow the full development of markets. The Risk Capital Action
Plan  and  the  Financial  Services  Action  Plan  are  the  tools  to  achieve  an  environment  that
fosters the liquidity in European financial markets.

Liquid capital markets are essential for SME finance. In venture capital, investors need exit
possibilities for their investments, and banks lending to SMEs need ways of increasing their
lending  and  reducing  risk  through  guarantees  or  securitisation.  Liquidity  would  also  be
served  by  removing  remaining  obstacles  from  venture  capital  funds  to  operate  across
borders,  eg.  by  creating  an  European  fund  structure  as  advocated  by  the  Commission’s
Communication “Investing in research: an action plan for Europe”21.

The European Union will continue to build a single financial market to support growth and
investment.  Besides  implementing  framework  legislation,  identifying  best  practices  and
using  the  open  method  of  cooperation,  the  Commission  can  be  a  catalyst  in  overcoming
identified gaps in the markets for SME finance.

The efficient use of limited public funds and the need to work with markets preclude the use
of grants in SME support. Experience has shown that SME finance can be increased without
increasing  bureaucracy  for  the  beneficiaries  by  using  venture  capital  investments  and  loan
guarantees implemented through local financial intermediaries. These instruments should be
focused on early-stage finance where the identified market gap is, and they should achieve
sufficient volume to make a difference. Because new  high-performance  companies  emerge
in unexpected fields, the instruments should benefit SMEs in all sectors. Clarity of purpose
and mechanisms also increase the visibility of European action.

To explore ways to further improve SMEs’ access to finance, the Commission will launch a
study  on  using  asset-backed  securities  in  enhancing  SME  lending.  Such  securitisation
transactions allow banks to sell loans from their balance sheets to other investors and expand
their lending capacity. The study will analyse the markets in Europe and compare them with
other  economies. The study  will also  assess  the  appropriateness  of existing  legislation  and
the role of the public sector action in using securitisation instruments in SME finance.

The  Commission  is  committed  to  the  long-term  development  of  European  venture  capital
markets,  in  particular  early-stage  venture  finance.  The  new  capital  requirement  rules
concerning equity exposures are designed to enhance financial stability and to protect bank
customers, including SMEs. In 2002, bank-related venture capital firms provided about 26%
of  the  total  venture  capital  in  Europe  and  securitisation  of  SME  lending  is  becoming  an
important  tool  for  increasing  liquidity  in  that  market.  The  effects  of  the  new  capital
requirement rules are the subject of a study being carried out on behalf of the Commission.

21

COM(2003)226, 30.4.2003.

17

                                                
6.  CONCLUSIONS

6.1.  Improving framework conditions

To  efficiently  promote  entrepreneurship  in  Europe,  there  are  three  areas  in  SME  finance
where further European, national and regional public sector actions should be focused.

(1) 

(2) 

(3) 

Improving the framework conditions;

Focusing on early-stage financing, in particular guarantees and microlending;

Increasing equity in SME balance sheets.

An entrepreneurial culture needs favourable framework conditions and the single European
financial  market  facilitates  entrepreneurs’  access  to  finance.  The  completion  of  the  Risk
Capital  Action  Plan  is  a  major  achievement  and  completing  the  Financial  Services  Action
Plan will lead to better availability of both bank lending and equity finance. These  actions
also improve the environment of entrepreneurs and mitigate the effects of the business cycle
by creating confidence in the future.

Bank lending will remain the main source of outside financing for a large majority of SMEs
and it needs to  be  promoted, in  particular  using  loan  guarantees.  A  specific  concern  is  the
low supply of credit to the private sector in the new Member States due to the perceived high
risk. Here, capacity building in the banking sector is essential to overcome the short history
of  available  data  and  experience.  Furthermore,  banks’  lending  capacity  can  in  general  be
increased by developing securitisation to sell SME loans off from banks’ balance sheets.

Member States and accession countries recognise the importance of SMEs’ access to finance
and  have  introduced  measures  that  aim  to  improve  the  provision  of  guarantees  for  bank
lending  and  risk  capital  investments  in  SMEs.  Many  have  also  introduced  additional  tax
incentives for companies and investors.

In  developing  more  targeted  public  sector  action  in  SME  finance,  the  need  to  use  limited
public  funds  efficiently  and  complying  with  the  State  aid  rules  of  the  Treaty  set  three
conditions. First, public action should be limited to areas of clear market failure; second, it
should  work  with  the  market  mechanism  to  overcome  the  failure;  and  third,  it  should  be
implemented by market professionals.

There are two areas where targeted policies are needed, early stage finance and equity base
of SMEs. First, the persistent gap in early-stage finance warrants direct public sector action
and  most  Member  States  have  specialised  SME  financing  institutions  to  address  this
financing  gap.  Second,  the  public  and  private  sectors  need  to  work  together  to  promote
stronger equity base for European SMEs.

6.2.  Focusing on early-stage finance, in particular guarantees and microlending

To  achieve  the  Lisbon  targets  the  public  sector  should  continue  to  work  with  the  private
sector to overcome the persistent gap in early stage finance and to support the knowledge-
based  economy.  To  provide  conditions  for  a  broad-based  growth  and  to  foster  R&D  and
innovation, both mainstream SMEs and entrepreneurial growth companies need national and
European financial instruments expanding both bank lending and equity investments.

Easily  and  widely  available  national  and  European  guarantee  instruments  that  share  risk
between  the  private and  public  sectors do  effectively  address  SMEs’  difficulties  in  getting
bank loans. From the SME viewpoint, simplicity and accessibility of guarantees mechanisms
is a condition for their efficiency, and this can only be achieved by using national and local
banks as intermediaries. The use of efficient and low-cost access technologies in accessing
guarantees and bank loans should be encouraged.

18

Microlending  can  provide  entrepreneurs,  mainstream  SMEs  and  entrepreneurial  growth
companies  with  decisive  help  and  it  can  be  effectively  promoted  through  guarantees  and
through improving the legal framework to facilitate fundraising and lending by microcredit
institutions.  Microlending  programmes  should  aim  to  be  sustainable  so  that  public  sector
support  could  gradually  decrease.  Cooperation  between  microfinance  institutions  and
business support service providers should be encouraged.

The new rules on the regulatory capital requirements are designed to increase the soundness
of the European banking system and they aim to align the calculation of regulatory capital
charges more closely with banks’ own economic processes and risk assessments. As the new
rules will bring increased stability and competition to European financial services markets,
they should confer benefits on SMEs and on European industry as a whole.

Banks  have  continued  to  develop  their  use  of  internal  rating  systems  for  their  customers,
including  SMEs.  This  is  consistent  with  the  basis  of  the  new  capital  requirements
framework. Rating systems require structured information about the firm and its prospects,
placing an obligation of analysis and transparency on the firm itself. Access to bank lending
can be facilitated by helping SMEs to adjust to the wider use of ratings.

Entrepreneurs  need  information  about  financing  alternatives  and  on  how  to  approach
different finance providers like banks, venture capitalists or business angels.

The use of national financial intermediaries and national programmes makes it possible for
the Community financial instruments to be used flexibly, tailored to the different financing
traditions providing additional leverage to programmes targeted at the financing gap in early
stage SME finance. To achieve results and visibility for European financial instruments, they
should be clearly focused on early-stage finance, have enough volume to be meaningful in an
enlarged Europe, and they should not be sector specific but benefit all SMEs. The possible
role of the public sector in enhancing the lending potential of banks through an increased use
of securitisation of banks’ SME lending portfolios should also be explored.

At  national  level,  both  the  Member  States  and  the  SME  financing  institutions  should
regularly evaluate the efficiency and appropriateness of their financial instruments and adjust
them as needed according to market demand.

6.3.  Increasing equity

The  needs  of  entrepreneurial  growth  companies  and  the  general  European  SME  sector  are
different,  but  both  need  stronger  balance  sheets  with  enough  equity.  Stronger  equity  base
will  also  enhance  the  chances  of  SMEs  by  improving  their  risk  rating.  The  sources  for
additional equity are retained earnings, informal risk capital investors, venture capital funds
and institutions providing quasi-equity instruments like subordinated loans.

Entrepreneurial growth companies will produce most of European growth and employment.
These  firms  need  equity  investments  from  business  angels  and  venture  capital  funds  in
several  financing  rounds.  For  this  reason  the  continuous  development  of  venture  capital
markets  is  essential  for  the  long-term  competitiveness  of  the  European  economy,  and  all
obstacles  that  hamper  the  functioning  of  the  single  financial  market  should  be  removed.
European level participation through risk sharing provides venture capital funds focusing in
early stage investments with credibility and ability to attract private funds.

Because  business  angels  provide important  advice and  financing  for  innovative  companies
before  they  have  access  to  the  formal  venture  capital  market,  promoting  the  possibilities
provided  by  business  angels  and  business  angel  networks  should  continue  to  receive
attention at regional, national and European level.

19

In  the  mainstream  SMEs  retained  earnings  are  the  best  form  of  financing  for  growth  and
investment.  However,  retained  earnings  often  suffer  from  unequal  tax  treatment  and  the
Member  States  should  review  their  fiscal  arrangements  taking  into  account  the  need  to
promote  firm  growth.  Furthermore,  experience  shows  that  investments  by  informal  risk
investors  like  friends,  family  and  business  angels  can  effectively  be  promoted  through  tax
breaks. The Member States and accession countries should likewise encourage the financial
transparency of SMEs in order to promote confidence and good governance.

20

Belgium

New initiatives in
risk sharing

Dialogue between
banks and SMEs

Denmark

New initiatives in
risk sharing

ANNEX

Overview of recent national actions in SME finance22

The  federal  level  “Participatiefonds”  is  renewing  and  widening  its  products.
The  new  “Solidaire  Lening”  microlending  programme  aims  to  finance
individuals  who  wish  to  become  self-employed  but  who  can’t  get  starting
capital. €1.24 million euros have been reserved for loans up to €12 000.

Several tax incentive schemes both for companies and individual persons have
been introduced or are under discussion.

At  regional  level,  the  Walloon  region  has  consolidated  its  SME  financial
support instruments to the new organisation “Sowalfin”. Its goal is to provide a
variety of instruments like loans, guarantees and venture capital. Furthermore,
“Les bourses de préactivité” provide grants of up to €15 500 for pre-seed and
seed capital purposes.

The Walloon region is also supporting business angel networks. The region is
thinking  about  introducing  a  SBIC-type  fund  system,  and  looking  ways  to
coordinate  better  finance  provision,  to  think  about  proximity  finance  and
microloans.

The Brussels region has launched a social fund “Brusoc” aiming to encourage
individuals to become self-employed.

financing 

The  Flemish  region’s  “Participatiemaatschappij  Vlanderen”  is  setting  up  a
centralised  SME 
institution,  “KMO-Financieringsagentschap
FIGARO”.  It  will  guarantee  bank  loans  (75%  public,  25%  private  risk)  and
aims  also  to  activate  risk  capital  provision  to  close  the  equity  gap  through
“ARKimedes-Fonds. These lend to or participate in venture capital funds with
attractive market-oriented terms.

At  federal  level  a  working  group  consisting  of  representatives  from  different
interest  groups  considered  SMEs  access  to  finance  and  presented  its
recommendations in a final report in February 2003. In Brussels, the “Comité
Bruxellois de Concentration Economique et Sociale” combines representatives
of social partners. In Flanders, a survey of SME financing has produced a list
of concrete proposals for different stakeholders.

The  government  is  creating  a  €67.3m  entrepreneurship  fund  aiming  to  close
financing gaps in cooperation with private investors, who should invest at least
50 %.

The existing Danish Investment Fund uses equity, convertible loans, and loans
with a profit component. It can invest either directly to companies or it can use
venture  capital  funds.  In  2002,  it  invested  €39.7m  directly  and  committed

22

For those Member States and other countries participating in the Multiannual Programme that answered
the Commission information request in May 2003.

21

                                                
€37.7m  to  venture  capital  funds.  Its  loan  guarantee  scheme  supporting  bank
lending  to  SMEs  will  be  redesigned  with  relaxed  participation  rules.  The
scheme has guaranteed in total €135m of loans.

Tax  initiatives  have  been  introduced  for  investment  funds  and  for  employee
stock options.

The government is continuing its support for loans and risk capital for pre-seed
activities.

Dialogue between
banks and SMEs

Several  guides  on  how  to  access  finance  have  been  launched  through
private/public cooperation. The regional business service system also facilitates
contacts between banks and SMEs.

Germany

New initiatives in
risk sharing

The fusion of KfW and DtA and the concentration of SME instruments into the
“KfW Mittelstandsbank” will lead to simplified instruments, will improve the
supply  of loans  and  will increase  the  importance  of  subordinated  loans.  Also
guarantee  systems  will  become  more  important.  Guarantee  schemes  which
have  their  costs  covered  by  risk  premiums  will  continue  to  be  an  important
tool.

In  venture  capital,  Germany  is  developing  new  SME  instruments  that  aim  to
provide  direct  investments.  KfW  is  running  pilot  projects  in  this  area.  The
“BTU-Early Stage Financing Programme” provides risk capital for innovative
start-ups.

The “pro mittelstand” initiative of the government will lower many taxes and
other charges for start-ups and microenterprises.

Dialogue between
banks and SMEs

A  dialogue  between  the  Ministry  of  Economy  and  Labour  and  banking
organisations has been established in order to ensure SME financing.

Spain

New initiatives in
risk sharing

A  SME  lending  securitisation  programme  gives  state  guarantee  for  securities
issued by investment vehicles. At least 80 % of the securitised lending has to
be  to  SMEs  and  at  least  80 %  of  the  obtained  funds  have  to  be  used  for  the
same purpose. Over three years a total of 12 investment vehicles have used the
programme for a total of €4.9bn of securities issued.

A new instrument has been introduced supporting technology-oriented SMEs.
In 2002 the Ministry for Science and Technology has €24m to give 7-year non-
interest  bearing  loans  without  guarantees  to  technology-oriented  risk  capital
funds. The Ministry participates in profit sharing for investments.

The  participation  loans  of  the  “Empresa  Nacional  de  Innovación”  have  been
amended  with a  similar technology-oriented  subordinated  loan  programme  of
€24m  (for  2003).  The  interest  rate  of  these  loans  between  €150 000  and
€900 000 is determined by the profitability of the firm.

AXIS  is  a  public  risk  capital  investor  who  gets  its  capital  the  Instituto  de
Crédito  Oficial  (ICO)  and  the  EIF.  ICO  offers  also  lending  programmes,
including  innovation  lending  and  microlending  (set  up  with  the  MAP
financial
microlending  guarantees), 

for  SMEs 

accessible 

through 

22

intermediaries.

Other  SME  support  programmes  target  information  technologies,  innovation,
research and industrial technologies.

Dialogue between
banks and SMEs

—

France

New initiatives in
risk sharing

The  creation  of  the  “fonds  d’investissement  de  proximité”  is  aimed  at
providing  regional  development  through  investments  in  SMEs.  The  funds
combine  profit  and  development  objectives.  Private  investors  in  these  funds
benefit from tax incentives. These funds can also finance guarantee funds and
mutual guarantee societies.

Tax  incentives  for  individuals  investing  in  unquoted  companies  have  been
increased and so has loss deductibility. Tax incentives have also been given to
business angels.

The application of the usury rate concept has been removed from loans made
for commercial or professional activities.

The  risk  sharing  activities  of  SOFARIS  are  being  reoriented  towards  small
enterprises with less than 10 employees, paying particular  attention to  simple
and  rapid  application  process  through  local  banks.  SOFARIS  guarantees
usually 50 % of the loan but for start-ups this is 70 %.

The  “Jeunes  Entreprises  Innovantes”  project  provides  tax  and  social  charge
advantages for small enterprises that have investment projects.

Dialogue between
banks and SMEs

Dialogue is usually conducted between credit institutions and SMEs, but wider
consultations  have  been  organised  on  eg.  the  proposed  new  capital  adequacy
rules.

Ireland

New initiatives in
risk sharing

The “Business expansion scheme” has provided tax incentives since 1984 for
private investors that invest in small and new companies in certain sectors for
long-term.  Total  funds  invested  1984-2003  were  €1041m.  The  “Seed  Capital
Scheme” provides tax refund for individuals setting up their own business.

Enterprise  Ireland  has  in  2002  decided  to  invest  €95m  into  12  new  venture
capital funds with a particular region and sector focus. Enterprise Ireland  has
also invested €9m in a regional fund focusing on export potential and €25m in
a high-tech fund. It has established a database of business angels.

Dialogue between
banks and SMEs

Department of Enterprise has had a round table from 2001, which has met six
times.

Luxembourg

New initiatives in
risk sharing

The  government  and  the  “Societé  Nationale  de  Crédit  et  d’Investissement”
have introduced a new start-up loan scheme for new entrepreneurs and existing
SMEs in the traditional sectors that fulfil certain conditions. The loan does not
require collateral and can cover up to 40 % of investment needs.

23

Dialogue between
banks and SMEs

–

Netherlands

New initiatives in
risk sharing

The guarantee scheme has been modified to become more accessible for start-
ups, including lengthening the definition of a start-up to under five years.

Dialogue between
banks and SMEs

–

Austria

New initiatives in
risk sharing

“Austria  Wirtschaftsservice”  (AWS)  has  introduced  a  “Gewinnwertpapier”,
which is a long-term (at least 10 years) loan instrument to an SME. It gives the
lender  right  to  a  share  of  the  profits  of  the  company  and  the  capital  is
guaranteed by the AWS. So far 14 such securities have been issued.

The AWS is developing a “Double-Equity-Fonds” scheme, which will double
the  own  capital  of  a  new  firm  through  guaranteed loan  or  venture  capital
participation (supported by the MAP SME Guarantee Facility).

AWS has relaunched its “Gründungbonus” scheme whereby the AWS gives a
14 % bonus to those saving for founding capital purposes.

At regional level, Styria has developed a “Venture Capital” action programme
giving  both  a  grant  for  advice  and  preparation,  and  at  most  €750 000  of  risk
capital. Lower Austria has set up “TecNet” fund investing start-up and early-
stage minority shares in technology-oriented enterprises. Burgenland has set up
a venture capital fund in the framework of Objective 1 regional funds.

Dialogue between
banks and SMEs

The  AWS  informs  financial  institutions  regularly  about  developments  in  the
SME  field.  At  Federal  level,  the  “Gründer-Round-Tables”  bring  together
stakeholders that are relevant for setting up businesses, and similar initiatives
exist also at regional level (eg. in lower Austria).

Finland

New initiatives in
risk sharing

The activities of the Finnish Industry  Investment Ltd have been refocused on
seed  and  start-up  risk  capital  financing.  In  addition,  the  state-owned  special
financing  institution  FINNVERA  has  been  given  the  right  to  do  equity
investments.

The  Finnish  National  Fund  for  Research  and  Development  (SITRA)  has  the
task to develop tools for firm creation and investment readiness.

The  government  is  thinking  of  tax  and  regulatory  incentives  for  private
investments in venture capital.

Dialogue between
banks and SMEs

—

Sweden

New initiatives in
risk sharing

To simplify and clarify its instruments, ALMI Business Partner has combined
its  three  microloan  products  into  one.  Loans  can  be  up  to  €27  000  with  a

24

maturity of up to 6 years, with or without collateral. The interest rate is higher
than normal interest rates of commercial banks so as not to crowd out private
lending. ALMI has to cover all default losses with its interest income.

A new program supports mutual guarantee schemes through regional guarantee
societies. Support is given to set up mutual guarantee societies and to provide
information. So far about €325 000 has been used for this purpose.

The  Swedish  Business  Development  Agency  (NUTEK)  supports  setting  up
regional business angel networks. Of the about 30 networks that are being set
up, 17 have received grants. NUTEK itself acts as a network of networks and
provides the networks with tools like handbooks and research. There is also a
project aiming to activate female business angels.

The  Innovation  Centre  Foundation  (SIC)  encourages  in  particular  young  and
female inventors and has built a regional innovation system aiming to have one
innovation office in every municipality.

Dialogue between
banks and SMEs

—

United Kingdom

New initiatives in
risk sharing

The  UK  government  is  a  minority  partner  in  eight  regional  venture  capital
funds  that  have  been  set  up  to  cover  the  equity  gap  in  venture  capital
investments up to €725 000.

is  also  participating  with  50 % 

The  government 
the  Community
Development  Venture  Fund  (Bridges  Fund)  which  is  operating  in  the  most
deprived  areas  of  England  and  invests  in  businesses  with  good  growth
potential.

in 

The  “Early  Growth  Funding”  programme  is  under  development  and  targets
start-ups with an average risk capital investment of €72 000.

Dialogue between
banks and SMEs

The Small Business Investment Taskforce advises the Small Business Service
in finance issues. It is composed of finance providers and users. In addition, the
Ethnic  Minority  Business  Forum  represents  the  interests  of  ethnic  minorities
and has an access to finance subgroup.

Cyprus

New initiatives in
risk sharing

The  Ministry  of  Commerce,  Industry  and  Tourism  has  introduced  a  loan
guarantee  scheme  for  manufacturing  SMEs  aiming  to  reorganise  or  expand.
Under  this  scheme  commercial  banks  lend  to  SMEs  with  an  up  to  100 %
government  guarantee  for  loans  up  to  €169 000.  The  interest  rate  will  be
subsidised by up to 2 percentage points when rates are over 5 %.

Dialogue between
banks and SMEs

—

Czech Republic

New initiatives in
risk sharing

The  Ministry  of  Industry  and  Trade  runs  a  newly  updated  programme
guaranteeing both loans and equity investments into SMEs.

Dialogue between

Representatives  from  all  stakeholders  are  represented  in  the  “National

25

banks and SMEs

Discussion  Group  on  SMEs”  which  participates  in  the  formulation  of  SME
policies.

Estonia

New initiatives in
risk sharing

The  Estonian  Credit  and  Export  Guarantee  Fund  (KredEx)  provides  loan
guarantees,  leasing  guarantees,  and  export  guarantees  through  financial
institutions.  The  KredEx  guarantees  are  counter-guaranteed  by  the  state.
KredEx guarantees have allowed bank lending worth of €47.3m.

Enterprise Estonia implements the public SME support policies. It gives grants
and advice for start-ups. The grant can be up to €6400.

Dialogue between
banks and SMEs

KredEx  has  organised  several  regional  round  table  meetings  that  have
improved understanding and have led to new bank products being launched.

Latvia

New initiatives in
risk sharing

The Mortgage and Land Bank of Latvia lending to SMEs is guaranteed by the
state. The bank has lent €39m to SMEs, partially with subsidies. The bank will
pay special attention to start-ups and microenterprises.

KfW  and  several  Latvian  banks  are  cooperating  to  lend  under  the  EU  Phare
programme  and  its  SME  Finance  Facility,  having  provided  in  total  €71m  of
loans and €11m of grants.

The  Ministry  of  Economics  is  planning  to  create  a  venture  capital  fund
providing risk capital for SMEs. The Latvian Development Agency already has
a  fund  called  “Norway  Latvia  Business  Development  Fund”  which  has  fully
invested its capital of €2.4m in SMEs.

The  “Latvian  Guarantee  Agency”  is  being  reorganised  into  a  limited  liability
company. It provides guarantees of up to 70 % for start-up lending.

Dialogue between
banks and SMEs

The “SME National Forum” is organised by the Mortgage and Land Bank of
Latvia  and  the  Ministry  of  Economics  to  enhance  the  dialogue  between  the
government and SMEs.

Lithuania

New initiatives in
risk sharing

The  government  has  established  a  guarantee  institution  called  “INVEGA”,
which provides guarantees of up to 80 % for investment lending to SMEs and
up to 50 % for working capital lending. It also provides interest rate subsidies
of  up  to  half  of  the  interest  paid.  For  2003,  €8.7m  has  been  reserved  for
guarantees.

Several  banks  are  participating  in  Phare-financed  SME  Finance  Facility
programmes in cooperation with the EBRD and the KfW, one of which has a
microlending  programme.  Three  banks  are  also  involved  in  other  Phare-
financed  SME  development  projects.  A  separate  programme  targets  women
entrepreneurs  and  is  supported  by  the  Council  of  Europe  Development  Bank
and the Nordic Investment Bank.

Dialogue between
banks and SMEs

Following the EU round table, a national round table of bankers and SMEs will
be organised in the second half of 2003. In addition, a recent seminar discussed
guarantee products for SMEs.

26

Malta

New initiatives in
risk sharing

The IPSE provides assistance to manufacturing sector restructuring, including
partial loan guarantees and partially subsidised interest rate.

Dialogue between
banks and SMEs

–

Poland

New initiatives in
risk sharing

The  loan  and  credit  guarantee  programme  “Capital  for  the  Entrepreneurial”
seeks  to  establish  a  system  of  local  and  regional  financial  institutions  (about
100 in all) to help SMEs to access finance. The government plans to allocate
€9m to the programme. The local and regional funds are being set up and will
provide loans up to €25 000 and guarantees for SMEs and entrepreneurs. The
aim is to ensure simple loan availability, not to provide preferential terms. The
participating institutions would be selected through a contest.

Dialogue between
banks and SMEs

–

Slovenia

New initiatives in
risk sharing

The  priority  is  to  overhaul  the  “Slovene  Enterprise  Fund”  to  better  provide
SMEs with a selection financial instruments, like loans with subsidised interest
rates,  loan  guarantees  and  venture  capital.  In  1996-2002  the  fund  lent  €87m
worth  of  subsidised  loans  and  invested  €174m  in  SMEs.  The  fund  is  now
introducing loans with grace periods and loan guarantees. Several SME support
schemes exist at local and regional level.

Dialogue between
banks and SMEs

The Ministry of Economy has carried out a survey of bank services to SMEs
and organised a dialogue on how to improve  their services.  A  national  round
table  has  existed  for  four  years  and  the  Chamber  of  Commerce  and  Industry
has also organised meetings between banks and SMEs.

Norway

New initiatives in
risk sharing

Although  a  comprehensive  supply  of  financial  instruments  for  SMEs  exist
(grants, loans, guarantees, equity investments), these have all been operational
for several years.

Dialogue between
banks and SMEs

—

Bulgaria

New initiatives in
risk sharing

The  Agency  for  Small  and  Medium-size  Enterprises  (ASME)  and  the
Encouragement  Bank  have  produced  a  plan  that  aims  to  establish  a  general
credit guarantee scheme for SMEs. An existing microcredit guarantee scheme
has guaranteed credits of €7.5m.

Several  banks  have  lending  programmes  that  target  SMEs,  including  a
cooperation programme with the KfW.

Dialogue between
banks and SMEs

—

27

Turkey

New initiatives in
risk sharing

The Small and Medium Sized Industry Development organisation (KOSGEB)
participates  in  the  Credit  Guarantee  Fund  of  Turkey,  which  has  guaranteed
€36m of loans. The KOSGEB also participates in the Partnership to the SME
Investments,  which  provides  capital  and  advice  for  SMEs’  investments.
KOSEB also cooperates in providing low-interest loans to SMEs.

A Credit Guarantee Fund provides guarantees of up to 50 % for bank lending
to SMEs. In addition, the Eximbank has a specific SME oriented export credit
line. It is also obliged to direct 30 % of its export guarantees to SMEs and it
provides interest rate subsidies for SMEs in underprivileged areas.

The Initiative Capital  Investment  Partnership aims  to increase  venture  capital
investments.

Dialogue between
banks and SMEs

The Chamber of Commerce is organising regular meetings on SME issues. The
banking sector and venture capital funds are also in contact on SME finance.

28