Finance for SMEs: Alternative supply mechanisms do exist

European Economic and Social Committee, 500th Plenary session of 9 and 10 July 2014. Voting procedure. (EESC Audiovisual Services).

Indisputably, one of the most crucial barriers to economic growth is the lack of adequate financing for SMEs, across the European Union. Indeed, the problem is more acute in the hardest hit by the financial crisis countries like Italy, Spain, Greece, Portugal and Ireland. In some other member states this setback is chronic. The SMEs account for almost 98% of the total number of businesses and produce 85% of new jobs. They constitute the backbone of the real economy and their role is more pronounced in the peripheral countries and the south of Europe than in the core member states, where a number of giant business groups prevail.

Given that, the banking system was and still is the only source of credit to SMEs, the financial crisis in Eurozone was directly and instantaneously transmitted to the real economy, mainly through a noticeable and gradual deprivation of the SMEs from working capital. As a result, the SMEs suffer for five years now from restricted access to loans for working capital. They are also hurt by dearly priced credit in the rare case where new loans are approved.

Working capital

Apart from working capital financing, development plans are also widely blocked by lack of credit in the crisis hit regions. Innovation undertaken by well-established SMEs and mid cap companies along with new business startups are likewise deprived of conventional bank loans. However, in those cases there are national or EU public funding sources or even subsidies which may alleviate the problem. In the case of working capital for SMEs though, the sole supplier of loans remains the shabby banking system.

Going through this long crisis period in Europe, it becomes pretty clear that sustainable economic growth can only be achieved, if the SMEs start faring well again. This is more accurate as far as the short-run growth potential of the entire economy is concerned. The creation of new jobs is firmly tied to the good functioning of existing SMEs, based solidly on adequate funding of their working capital. By the same token, financial risks associated to well-established SMEs are lower compared to innovation attempts and start-up financing. In conclusion, if decision makers want to see the Eurozone economy start growing again at a sustainable rate, the problem of working capital financing for SMEs has to be resolved here and now.

No time to lose

In view of that, the European Economic and Social Committee (EESC), a consultative body of the European Union representing employers, workers and other civil society bodies, has embarked on an exercise to put together recommendations in relations to business financing. To this effect last January the EESC decided to draw up an own-initiative opinion on “Finance for business: an investigation of alternative supply mechanisms”. After five months, EECS’s Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible for preparing the Committee’s work on the subject, adopted this opinion on 17 June 2014. Subsequently, at its 500th plenary session, held on 9 and 10 July 2014 the EESC endorsed the opinion by 141 votes in favour and 4 abstentions. The report was presented by Michael Smyth, President of the Section for Economic and Monetary Union, appointed to the EESC as a member of Group… at Jordanstown, Northern Ireland, since 2008.

This study is an extensive presentation of the financial problems of the business sector. Understandably, the EESC work concentrated on the problems encountered by the SMEs. The obvious reason is that the big companies can be adequately financed from other sources (for example equity and bond issues), not depending on loans from the crippled by the crisis banking system.

On the contrary, the SMEs invariably have to turn to banks for credit. It is not only that though. The Eurozone banking system is far from being seamless. The credit crisis has led to a pronounced fragmentation of the European financial market. Therefore, the cheap money supplied by the European Central Bank to the lenders doesn’t reach all the member states. As a result, Italian and Spanish SMEs pay much higher interest rates for similar business risk (if they get a loan) compared to their German and British counterparts. But let’s return to EESC findings.

There is a way

The EESC study, after producing an exhaustive account covering the European Central Bank, the European Investment Bank, European Investment Fund and the European Commission’s initiatives to alleviate the financial difficulties of the SMEs, the inquiry concludes that, “To date this response has not been proportionate to the problem”. The study also observes that, “Trends in lending for working capital are difficult to identify precisely due to the lack of data, but the broad trend can be seen in the ECB data of lending to non-financial businesses. These data have been falling for the past four and five years and only in the last few months show some signs of recovery”.

After reviewing the response to SMEs financial problems that various member states have provided, the EESC report notices that, “One of the most interesting initiatives is the Funding for Lending Scheme (FLS) in the UK and it is worth a closer look”. For two years now this program conducted jointly by the British government and the Bank of England has tangible results.

Targeted financing

In brief, the British scheme works as follows: “The scheme offers discounted funding to all banks, even to those banks which are deleveraging. The scheme has no upper limit as to the amount of funding banks can tap into. To illustrate, if a participating bank has a stock of business lending of € 100 billion at the start of the scheme, it could draw down at least € 5bn in funding. If the same bank then increased its net SME lending by a further € 1bn, it would be entitled to draw down a further € 5bn from FLS. This five to one ratio of drawdown to new net lending to SMEs, together with the cheaper cost of funding, provides powerful incentives to banks to expand lending”.

A similar monetary scheme has been recently introduced by the ECB under a monetary initiative named ‘Targeted Long Term Financing Operations’. The EESC report comments as follows, “On 5 June 2014 the ECB announced a set of liquidity measures to boost bank lending to SMEs…ECB’s main proposal, called Targeted Longer-Term Refinancing Operations (TLTROs), is similar to the FLS as outlined in this opinion”.

Reselling loans

Last but not least the EESC document encompasses nine “Other proposals to improve the flow of finance to SMEs”. They include measures to enable mutual, cooperative and collective institutions to lend to SMEs. They also include a suggestion, “…to insure portfolios of unsecured SME loans that banks could then sell to non-bank investors”.

It becomes clear that the EESC, by being deeply concerned about the growth potential of Europe, has come up with a remarkable research paper which can guide the EU decision makers in their quest for the best policies.