Firstly, the complex economic situation across Europe has reduced demand for their goods and services and secondly the sovereign-banking loop meant deteriorating funding conditions for banks with headquarters in those countries – which, in some cases also had solvency issues. Both translated into difficulties in accessing credit for those companies.
However, the behaviour of firms has varied considerably depending on their size. While bigger firms have been able to resort to funding via own funds, intra-group funding or the capital markets, small to medium enterprises (SMEs) are generally more dependent on bank credit.
According to the European Central Bank’s (ECB)
‘Access to Finance’
survey, around 13% or euro area SMEs point to access to finance as their most pressing problem, with the percentage rising to 17% for SMEs giving this answer in Spain. In economies with such a high proportion of SMEs such as Spain’s, employment and investment have been seriously eroded during the crisis, and a significant number of enterprises have been forced out of business.
Both the demand and the supply of credit have improved in the most recent few quarters, but some factors still have a negative influence on conditions. In particular, the economic context is still affecting both the demand and the supply of credit. On the one hand, demand is negatively affected mainly by the weak economic cycle, low potential growth and a deleveraging process still far from finished, against a backdrop of low confidence. On the other hand, supply is suffering the influence of risk perceptions, cost of funds, fragmentation, balance sheet constraints and regulatory burdens. However, despite these negative factors expectations point to a further improvement in both demand and supply.
Has the stock of credit already started recovering? No, although this is not necessarily bad news. Deleveraging needs to continue in over-indebted companies and sectors, but it has to be compatible with the provision of new credit to solvent demand. We are following a typical historical pattern, as the flow of new credit improves first, followed by stocks. For example, in Spain new loans to SMEs are starting to increase, albeit gradually, while the flow of new credit to big corporates continues to decrease, as they have other funding alternatives available. Overall, total new lending will exceed repayments by end-2015, so the stock of credit to the private sector will further increase.
What about credit conditions? Although they have not normalised yet in peripheral economies, they have started to improve. During the crisis, the price of credit was significantly higher in peripheral than in core economies. For example, a credit to an SME (using loans of up to €1m as a proxy) had a price of around 5% in Spain up to mid-2014 – compared to around 2% in France. Two factors explained most of that difference according to our estimates: the sovereign risk premium and the credit risk (measured by firms’ default rate), which do not play a role in core countries.
The good news is that financial fragmentation is gradually fading away – even if the problem is not completely solved. Consequently, while there is a time lag, the reduction in the sovereign risk premium and in the ECB official rate is translating into a fall in the cost of credit for SMEs. More recently, the reduction in the non-performing loans ratio is also having an effect in the moderation of credit prices, and that trend is expected to continue in the coming quarters. In fact, the gap between the interest rate of credit to SMEs between Spain and France has decreased from three to two percentage points.
The ECB’s Helping Hand
What factors have been contributing to the reduction in financial fragmentation in the eurozone? The ECB has played a major role implementing a plethora of measures: auctions with full allotment until end-2016, targeted long-term refinancing operations (TLTROs), purchases of private assets and, launching this month, quantitative easing (QE).
The purpose of those measures is twofold. Firstly, they serve as an anchor of monetary policy expectations and of the yield curve; mitigating uncertainty on future funding conditions for the financial system. Secondly, they improve the lending channel. These policies go beyond providing liquidity, which is no longer that necessary nowadays – they also increase confidence in the economic recovery and therefore incentives for solvent demand to ask for credit.
Additionally, the launch of the Banking Union initiative in the European Union (EU) has been extremely important. In its current state, which could be called 1.0 (single rulebook, single supervision and advances in single resolution) it has played a major role in reducing financial fragmentation. However, pending steps include completing the banking union (single deposit guarantee, public backstop), fiscal union (common budget, common independent fiscal authority, risk sharing via eurobills and a debt redemption fund), reforming EU treaties and the capital markets union. It is crucial not to lose reforming momentum when the situation has improved only partially.
How could public policies help reinforce the improvement in European firms’ funding? Firstly via risk sharing, as liquidity is no longer an issue. Initiatives such as public guarantees, or co-financing are welcome. Furthermore, that lower risk to be absorbed by banks should be recognised in terms of capital consumption, where a beneficial treatment of credit to SMEs would be useful.
The second group of policies to be pursued are those that increase SMEs’ size and foster exports, as those are the firms that have better prospects. In that sense, it would be useful to avoid what are known as ‘cliff effects’ (disproportionate fiscal and tax policies based on companies’ size) and to simplify administrative processes.
In the third place, alternative finance must be promoted as a complement to bank credit, but it will be a long-term process that requires changes in governing law, corporate law, transparency and information. A more balanced European financial system should be pursued, including banks, non-banks and capital markets, and always preserving the level-playing field.
Public initiatives could include fiscal incentives for investors or SME-backed bonds being eligible as ECB collateral, and the capital markets union will be an important force towards this goal. However, given the current limited size of alternative finance (around 0.5% of gross domestic product (GDP) in Spain) it cannot replace bank lending in the short- to medium-term, so it would be preferable to have a sound financial system to support the economic recovery.
Taking a perspective from the recent crisis, what matters is learning from experience in order to avoid or mitigate the possible consequences of an eventual new crisis. Firstly, the larger the firms and the more oriented towards exports, the better prospects they will have. Secondly, initiatives at the European level that point to a more important convergence of national policies are the most effective to overcome difficulties.
We need more Europe – not less. The endgame is a truly integrated market in which consumers and corporates can access finance without regard of their location, but depending solely on their creditworthiness.
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