Making Small Beautiful Again: The Challenge of SME Loans
If financing is the lifeblood of European small businesses, then the effect of the financial crisis was similar to a cardiac arrest. The flow of affordable credit from banks was choked off and small and medium-sized enterprises (SMEs) were hit hardest.
SMEs are vital to the European economy. They account for 99 out of every 100 businesses, two in every three employees, and 58 cents of each euro of value added of the business sector in Europe. Improving access to finance would therefore not only revive small businesses, but also support a strong and lasting recovery for Europe as a whole.
Europe’s small businesses rely heavily on banks for credit. In 2014, more than two-thirds of SMEs in Europe used bank financing, while less than one fifth used non-bank financing sources. This dependence makes them vulnerable to banking sector difficulties. When the crisis hit, banks raised interest rates and rationed credit to SMEs more tightly than for larger firms.
It's now six years since the global financial crisis and Europe is still struggling under huge corporate debt and millions of nonperforming loans.
Small and medium-sized enterprises (SMEs) are bearing a disproportionately heavy burden of these close-to-default loans. The ratio of nonperforming SME loans is double that of their larger corporate cousins. Given the importance of smaller businesses to the economy, addressing this issue could help lay the foundations of a sustainable economic recovery.
SMEs in Europe are defined as employing fewer than 250 people and having annual sales of less than € 50 million. Unfortunately, their small size often makes it harder to find a way out of a restrictive loan due to poorer financial awareness and fewer tools at their disposal. Smaller businesses are more likely to suffer from a lack of expertise in loan restructuring, costly or complex insolvency regimes, and higher costs of distressed financing. Strict insolvency laws often dampen entrepreneurial spirit by denying the owners of failed businesses the opportunity to start afresh. On top of these unique difficulties, small businesses share the same challenges as bigger corporations in the current environment: cash-strapped banks, weak insolvency systems and inadequate legal enforcement tools.
There's no doubt that our governments and institutions could be doing more to improve the situation. Despite the large loan volumes, financial data about SME loans is still relatively limited. Certain European governments have begun to take measures to reform the harsh insolvency and bankruptcy regulations. Cyprus, Greece, and Ireland have all increased supervision of problem loan management in banks. It is hoped that the new Single Supervisory Mechanism, led by the European Central Bank, will harmonise nonperforming loan management throughout the Eurozone. Governments have also created tax and other economic incentives for small and medium-sized enterprises to restructure their debt.
Nevertheless, the pace of change remains too slow for tens of thousands of SMEs across Europe. The number of nonperforming loans in the EU periphery is growing by 2.5% every year. Simpler, more cost-effective insolvency procedures for small firms would be a good start because, after all, time is money. While banks hesitate to restructure problem loans, the value of the business goes down. It's comparable to arguing over how to divide a melting ice cream.
An increase in out-of-court settlements is essential to restructuring loans more quickly and more cheaply. If implemented carefully, this could also give legitimate entrepreneurs the chance to shed unsustainable debt and make a fresh start.
Meanwhile, tougher banking supervision would incentivise banks to tackle their problem loans and assist viable but struggling small businesses.
Europe’s entrepreneurs and smaller businesses could be the backbone of the European recovery, but too many are being permanently weakened by problem loans. Resolving this situation would free up precious resources to help healthy SMEs flourish and new ones emerge.
It’s time to make small beautiful again.