SME Market Report. Overview 2015 H1

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1 SME Market Report 2015 H1 The Central Bank of Ireland s SME Market Report is compiled by economists in the Financial Stability Division and aims to collate information from a wide range of internal and external sources to give an up-to-date picture of developments in the Irish Small and Medium Enterprise (SME) credit market.1 The report provides information on credit demand, credit access, loan terms and conditions, loan default, interest rates and credit market concentration. The report is released twice yearly. The analysis in this edition refers to data released between 31st of December 2014 and 30th of June Data used to populate this report come from Central Bank of Ireland Credit, Money and Banking statistics, the Red C SME Credit Demand Survey, the European Central Bank (ECB) / European Commission (EC) Survey on the Access to Finance of Small and Medium Enterprises (SAFE), the ECB Monetary and Financial Statistics and Loan-Level data collected by the Central Bank of Ireland from Irish domestic banks. The data sources are detailed in Appendix 1 and the SME definition adopted in each data source is defined in Appendix 2. Overview Trends in SME outstanding credit and new lending are presented in Section 1. The stock of non-financial, nonreal-estate credit continues to decline and currently stands at e21.4 billion, a 10.4% reduction since the last report. Annualised gross new lending, however, has been increasing steadily since early 2014 and is currently e2.6 billion, the highest value since Section 2 presents SME loan application and rejection rates. While overall credit applications are similar to the last report (currently 32%), applications for new loans and leasing/hire-purchasing show continued growth. In line with the last report, the majority of applications are for working capital purposes (48%), particularly so for Micro firms. Applications are also high for growth and expansion (25%) and for new vehicles/equipment (29%). Rejection rates, having shown reductions in the previous report, have increased, from 14% to 16%. Section 3 shows that default rates on outstanding credit balances have declined, and currently stand at 23% by volume and 37% by balance. The share of performing loans transitioning into default status has lowered compared to the previous reporting period. Interest rates on overdrafts are shown to be in excess of 7%, regardless of overdraft amount. For loans, interest rates on values up to the median balance are also above 7%, but then decrease for higher amounts. Section 4 compares credit conditions in Ireland to other euro area Member States. The share of Irish SMEs stating access to finance as a high concern has increased slightly, and is above EU1 countries but below EU2 countries (see Appendix 1 for country groupings). Loan applications and borrowing for investment purposes are low in Ireland, while borrowing for working capital is high. The data also show that current rejection rates on loans and overdrafts are above euro area averages. Furthermore, it is apparent that more Irish SMEs reported interest rate increases rather than decreases in the latest survey, which is in contrast to other euro area countries. Interest rates and new lending volumes are compared to the euro area in Section 5. Interest rates on Irish SME loans are high relative to other euro area member states. The interest rate differential between small and large loans is also high. This section also shows that new lending as a share of domestic demand is low in Ireland, having been close to euro area averages between 2006 and Section 6 demonstrates that the concentration of new lending to SMEs, while exhibiting some improvement over the last six months, remains high. Box 1 and Box 3 describe two EU-wide policies intended to increase bank lending to the real economy Targeted Longer-Term Refinancing Operations and the SME Supporting Factor. Box 2 describes the use of personal guarantees in Irish SME lending. 1 Enquiries and comments relating to this document should be addressed to: Financial Stability Division, Central Bank of Ireland, PO Box 11517, Spencer Dock, North Wall Quay, Dublin 1. fsdadmin@centralbank.ie

2 1 Central Bank of Ireland Credit, Money and Banking Statistics 2 Figure 1 presents the value of outstanding credit to non-financial, non-realestate small and medium-sized enterprises (SMEs), which account for 41% of total SME credit in March Figure 1 shows that the stock of SME credit has fallen from e36.6 billion in Q to e21.4 billion in Q1 2015, a 41% decline. Since the last SME Market Report, the stock of credit has reduced by 10.4% (Q versus Q2 2014). Figure 1. Credit outstanding to SMEs, Q Q Figure 2 reports outstanding SME credit for the six largest sectors in Ireland (excluding financial intermediation and real estate SMEs). Compared to the last report, all sectors show continued decreases (Q versus Q2 2014), particularly the Construction (-27%), Hotel/Restaurant (-17%) and Manufacturing (-15%) sectors. Figure 2. Credit outstanding to SMEs, by sector, Q Q1 2015

3 3 Figure 3. New SME lending (4 quarter rolling summation, by quarter), Q Q Figure 3 presents annualised (rolling summation over previous four quarters) gross new lending to SMEs (excludes financial intermediation and real estate SMEs). 2 New lending, having been close to e2.5 billion before 2012, reduced to approximately e2 billion in 2012 and Since the beginning of 2014, new lending has steadily increased, and the latest data show annualised new lending slightly above 2011 levels (currently e2.6 billion). Figure 4. New SME lending, by sector (4 quarter rolling summation, by quarter), Q Q Figure 4 presents gross new lending trends for the main business sectors. The Primary sector (agriculture) has consistently received the largest amount of new lending, followed by the Wholesale/Retail and Business and Administrative Services sectors. Since the last report, all sectors except manufacturing show an increase in annualised new lending (Q versus Q2 2014), particularly the Hotel/Restaurant (increased by 69%), Wholesale/Retail (59%) and Construction (40%) sectors. 2 Gross new lending is defined as the amount of new credit facilities drawn-down during the quarter by SME counterparties, i.e. where this credit facility was not part of the outstanding amount of credit advanced at the end of the previous quarter.

4 2 Red C SME Credit Demand Survey 4 Figure 5 displays the percentage of SMEs that applied for bank finance. The declines in application rates observed in previous surveys appears to have stabilised, with overall credit demand (all SME size categories) showing a small increase in the latest survey (32%, up from 31% in September 2014). This increase is predominantly driven by large increases for Medium firms, whose application rate increased from 32% to 40%. Figure 5. Application rate for bank finance, September March 2015 Figure 6 disaggregates the overall application rate into the various bank finance products (across all SME size categories). 3 In the latest survey, application rates are highest for new loans (37% of all applications), renewals/restructures of existing overdrafts (33%) and leasing/hire-purchasing (32%). The recent growth in applications for new loans and for leasing/hire-purchasing observed in previous surveys continued in the latest survey wave (up from 34% and 28% in the previous survey). Figure 6. Bank finance products requested, September March Figure 6 shows finance product applications as a share of firms that made an application. Total shares sum to greater than 100% as firms can apply for more than one product in a six-month survey period.

5 5 Figure 7. Reasons declared for credit application, October March 2015 The majority of credit applications in the latest survey are for working capital purposes (48% of all applications across all SME size categories). This rate decreases for larger firms. 4 Applications are also high for new vehicles/equipment (29% across all SMEs) and growth/expansion (25%), and these rates increase with firm size (although the rate for vehicles/equipment for Medium firms is slightly below small- SMEs). Property-related applications are cited by 11%. Figure 8. Reasons declared for credit application, September March 2015 Figure 8 shows how the three main reasons given for credit applications have changed over time. Borrowing for working capital has generally decreased, while borrowing for growth/expansion and vehicles/equipment has increased (all SME size categories). While there are no large changes since the last survey, borrowing for new vehicles/equipment shows a further increase (up 2 percentage points). By SME size, there are a number of notable changes since the last survey borrowing for growth shows increases for Medium firms but decreases for Micro firms, and borrowing for working capital has decreased for Micro firms but increased for Small firms. 4 Working capital refers to requests for the purposes of cash flow management, decline in business revenues, delayed customer payments, increased supplier costs and increased bad debts. Totals sum to greater than 100% as firms may respond with multiple reasons for requesting bank finance

6 Figure 9 displays rejection rates on SME finance applications. 5 While a general decrease is observed since September 2012, a slight increase is apparent in the latest survey across all SMEs, the rejection rate has increased from 14% to 16%. This is, however, driven by increases in rejections for Small firms (up to 19% from 11% in the last survey). The remaining size groups show continued reductions, albeit at a slower pace than the previous survey. Figure 9. Bank finance rejection rates, September March Rejection rates are for those SMEs applying for credit and having received a decision in the last six months. These rates are for all finance types described in Figure 6.

7 3 Central Bank of Ireland Loan-Level Data 7 Figure 10. SME outstanding balance and default rates Dec Jun Dec Total Balance (em) 21,042 20,684 19,176 Average Balance (e) 71,102 67,423 67,681 Median Balance (e) 9,954 9,897 9,779 Default Rate by Count (%) Default Rate by Balance (%) Loan-level data on the population of SME loans in Ireland are employed to describe lending trends and loan performance. 6 Figure 10 shows that the outstanding stock of SME loans continues to decline, with total balances reducing from e20.7 billion in the last report to e19.2 billion in December 2014 (an 7.3% decline). Default rates show an improvement over previous reports, and currently stand at 22.7% by count and 36.9% by balance. Figure 11. Transition between performing and default, June December 2014 Performing Default Total Dec 14 Dec 14 By Count % % Number Performing Jun ,730 Default Jun ,135 By Balance % % em Performing Jun ,808 Default Jun ,421 Figure 11 presents the share of SMEs that changed loan performance status between June 2014 and December The latest data show that 2.2% of performing loans in June have switched to default status by December (5,890 loans). By outstanding balance, these loans represent a higher share (3.5% of performing loans). The data also show that 4% of defaulted loans had switched to performing (2,612 loans). These figures are an improvement over the previous report, with smaller numbers of SMEs switching from performing to default status (7,530 previously) and higher numbers switching from default to performing (2,049 previously). 6 These data are collected every six months with the latest data from Decemeber The finance types included in Figure 10 are predominantly comprised of loans, overdrafts, hire-purchasing and leasing.

8 Figure 12 presents default rates across the main economic sectors, by loan count and by current outstanding balance. 7 As with the last report, default rates are highest in the Construction, Hotels/Restaurants and Personal sectors and lowest in the Manufacturing, Primary, Other Community, Social and Personal Services (OCSP) sectors. The balance-adjusted default rate is higher than the share of defaults in all sectors, indicating the defaulted loans have higher balances on average. Figure 12. SME default rates by sector, December Compared to the sectoral breakdown, default rates are evenly spread across regions (Figure 13). 8 By loan balance (current outstanding), default rates are highest in the West (44%) and Mid-West (43%) and lowest in Dublin (36%) and the Midlands (34%). By loan count, default rates are highest in Dublin (29%) and the Mid-East (24%) and lowest in the Midlands (21%) and South-East (both 20%). Figure 13. SME default rates by region, December Sectors with small exposures are subsumed into larger sectors for exposition purposes. The Electricity, Gas, Steam and Air Conditioning Supply, and Water Supply, Sewerage, Waste Management and Remediation Activities sectors are included with the Manufacturing sector; the Transportation and Storage sector is included with Wholesale and Retail; the Human Health and Social Work, and Education sectors are included with the Other Community, Social and Personal sector; the Information and Communication sector is included with Business and Administrative Services. The Personal sector involves lending for the purposes of house purchase, property investment and consumer lending that is managed in the business banking units of the subject banks. 8 Nomenclature of Territorial Units for Statistics (NUTS) regions - Border : Cavan, Donegal, Leitrim, Louth, Monaghan, Sligo; Mid-East : Kildare, Meath, Wicklow; Mid-West : Clare, Limerick,; Midlands : Laois, Longford, Offaly, Westmeath; South-East : Carlow, Kilkenny, Tipperary, Waterford, Wexford; South-West : Cork, Kerry, West : Galway, Mayo, Roscommon.

9 Figure 14. SME default by loan balance percentile, June 2014 and December 2014 In Figure 14, the SME loan book is divided into one hundred percentiles of outstanding balance and the default rate is plotted for each percentile. This is displayed for the latest data (December 2014) and for the previous reporting period (June 2014). Default rates are below 20% for the majority of loan balances (between the 20 th and 75 th percentiles), but increase considerably for higher and lower amounts. Compared to June 2014, December shows lower default rates on the majority of balances. 9 Figure 15. Mean interest rate by loan balance deciles, December 2014 Figure 15 displays the mean interest rate by loan balance decile for amortising loans and overdrafts. 9 Interest rates on overdrafts are consistently above 7% (with the exception of the largest overdrafts). For amortising loans, interest rates are slightly above 7% up until the median balance and then drop considerably for higher amounts. For the largest loans, interest rates are slightly above 3%. 9 The balance in Figure 15, for both amortising loans and overdrafts, is the summation of current outstanding and undrawn balances (for overdrafts, this summation equates to the total credit limit). Amortising finance products are comprised of loans, hire-purchasing and leasing.

10 Figure 16 describes lending volumes for amortising loans in the three latest loanlevel datasets. New loans are defined as those which originated in the six months prior to each respective dataset date. 10 While the number of loans has decreased between June 2014 and December 2014, the total balance has increased. 11 This is due to a significant increase in the average loan balance between these dates. The average interest rate on new loans (weighted by balance) has decreased from 5.5% in June to 4.9% in December. 12 Figure 16. New amortising loans description Dec Jun Dec Count 21,978 26,799 23,039 Total Balance (em) 1,178 1,062 1,358 Average Balance (e) 53,593 39,640 58,962 Median Balance (e) 15,951 15,402 16,652 Average Interest Rate (%) Average Term (years) Figure 17 describes new overdrafts in the latest three loan-level datasets. As with Figure 16, new overdrafts are defined as those issued in the six months leading up to each respective dataset date. The overdraft balance is defined as the summation of outstanding and undrawn balances (equal to the credit limit). The number of overdrafts and the total volume of credit has decreased between June and December However, the average and median credit size has increased. Figure 17. New overdraft description Dec Jun Dec Count 5,804 7,284 6,076 Total Balance (em) Average Balance 13,989 12,514 14,582 Median Balance 6,500 6,000 6,500 Average Interest Rate (%) As with Figure 15, the loan balance is defined as the summation of outstanding and undrawn balances. 11 Trends in new lending differ to those presented in Figure 3 due to compositional differences between these sources while the data in this section are from the three main credit institutions (Bank of Ireland, Allied Irish Banks and Permanent TSB), the trends in Section Figure 3 are based on all credit institutions in the State. Furthermore, the data in this section include renegotiated and restructured loans, which are excluded from Figure The unweighted average interest rates are 7.21%, 7.23% and 7.03% respectively.

11 Figure 18. New amortising loan balance distribution, June 2014 and December Figure 18 displays the loan balance distribution of new amortising loans. 13 New loans are defined as those issued in the six months prior to each respective data release date. It is evident that the majority of SME loans have balances of less than e50,000. The median balance has increased from e15,402 in June 2014 to e16,653 in December Total loan balance is the summation of current outstanding and undrawn balances. Amortising finance products are comprised of loans, hire-purchasing and leasing. Balances above e200,000 are excluded for exposition purposes (4.6% of the sample in December 2014). Renegotiations or restructuring of existing loans are included in these data.

12 4 ECB/EC SAFE Survey 12 The ECB/EC s Survey of Access to Finance of Small and Medium Enterprises (SAFE) is used to compare credit conditions in Ireland to that of the euro area. 14 Figure 19 describes how pressing a problem access to finance is for SMEs. 15 The steady improvement observed in Ireland up to September 2014 appears to have stabilised. In the latest SAFE survey, the share of SMEs in Ireland reporting a high concern slightly increased (from 35% to 37%) and is currently above EU1 (30%) but below EU2 (44%). Figure 19. Concerns on access to finance, April March 2015 In the SAFE surveys, SMEs are asked about bank willingness to provide credit (Figure 20). An improving situation is evident. While most SMEs report an unchanged situation in the latest survey, more SMEs state an improvement than a deteriortion in all regions. In the latest survey, Ireland has a lower share of SMEs stating a deterioration (13%) than EU2 (21%) and EU1 (18%). Furthermore, the share of SMEs stating an improvement (33%) is similar to EU2 (34%) and above EU1 (25%) Figure 20. Perceptions of bank willingness to provide credit, April March The survey is conducted twice-yearly with the most recent survey covering the period from October 2014 to March Ireland is compared to two groups of countries: EU1 which comprises of Austria, Belgium, Germany, Finland, The Netherlands and France, and EU2 which comprises of Portugal, Italy, Spain and Greece. 15 Responses range from 10 ( extremely pressing ) to 1 ( not at all pressing )

13 13 Figure 21. Application and discouraged borrower rates for loans and overdrafts, October March 2015 Figure 21 presents application and discouraged borrower (SMEs that did not apply because of fear of rejection) rates for loans and overdrafts in the most recent SAFE survey. 16 Loan application rates in Ireland (21%) are below those in EU2 (33%) and EU1 (28%). For overdrafts, rates in Ireland (26%) are similar to EU1 (26%) but are considerably below EU2 (39%). The share of discouraged loan borrowers in Ireland has decreased relative to the last SME Market Report, from 15% to 10%. This rate is now similar to EU2 but approximately four percentage points higher than EU1. The share of discouraged overdraft borrowers is also low in EU1. Figure 22. Rejection rates for loan and/or overdraft applications, April March 2015 Figure 22 presents rejection rates for loans and overdrafts applications. 17 Rejection rates, while showing a large reduction in the last report, have increased again. The current rejection rate of 15.7% in Ireland is higher than EU1 (9.1%) and EU2 (9.5%), with the latter showing large improvements. 16 Following the SAFE reports, this data only include SMEs for which bank loans and overdrafts are relevant. 17 SMEs that applied for both a loan and an overdraft but received a rejection for either are treated as rejected for Figure 22. The base is all SMEs that applied for either product. Analysis of overdrafts is isolation shows a more favourable trend with respective rates of 11.4%, 10%, 7.5%, 5.7%, 5.2% and 7.1%. The current overdraft rejection rate (7.1%) is slightly above EU1 5.9% and EU2 5.6%.

14 Figure 23 describes the purpose of financing in the latest SAFE survey. 18 Similar to Figures 7 and 8, borrowing for working capital is high in Ireland, with 59% of respondents stating this purpose (compared to 45% in EU2 and 38% in EU1). Borrowing for fixed investment in Ireland (23%) is behind EU2 (34%) and EU1 (49%). Borrowing for hiring, research/development and refinancing is lower in all regions compared to other categories. Figure 23. Purpose of financing, October March Figure 24 describes changes in interest rates, as reported by SMEs that applied for a loan and/or overdraft. In Ireland, while more SMEs report increased rather than decreased interest rates (in every survey since 2012), the share of increases has, in general, declined over the period. However, in the latest survey in Ireland, over twice as many SMEs reported an increase than a decrease (43% versus 17%). This is in contrast to EU2 and EU1, where the share of increases is lower than the share of decreases (26% versus 36% in EU2 and 51% versus 10% in EU1). Figure 24. Change in credit conditions: interest rates, April March The format of this question changed slightly to the previous SAFE survey where respondenst were asked about the purpose of external financing. In the current survey, this question is extended to external sources or from funds generated by your enterprise. In Figure 23, Investment refers to investment in property, plant, machinery or equipment, Work. Cap. refers to inventory or working capital, Hiring refers to hiring and training of employees, R & D refers to developing and launching new products or services and Refinancing refers to refinancing or paying off obligations. The shares presented exclude SMEs who responded with don t know or not applicable.

15 15 Figure 25. Change in credit conditions: loan size, April March 2015 Figure 25 presents changes in loan size availability, as reported by SMEs. The majority of SMEs report an unchanged situation in each survey. However, in all regions, the net percentage (increases minus decreases) has generally increased, particularly so in Ireland and EU2. Compared to the last report, the latest data show a slight increase in the net percentage in all regions, indicating that loan size availability continues to increase. Figure 26. Change in credit conditions: collateral, April March 2015 Figure 26 presents changes in collateral requirements, as reported by SMEs. In all regions, the share of increases is higher than the share of decreases, implying that collateral requirements are, in general, tightening in the euro area. However, this rate of increase is slowing, with declining shares of SMEs reporting collateral increases, particularly so in Ireland and EU2.

16 5 ECB Monetary and Financial Statistics 16 Figure 28 presents interest rates on loans to Irish non-financial corporations (NFCs) for various originating values. 19 Given the mean loan balance of e67,681 in the Loan- Level data (see Section 3), rates on loans under e0.25 million are a reasonable proxy for SME cost of credit. SME interest rates are higher than that for larger firms. For example, the average interest rate for SMEs for the last 6 months of data (October 2014 to March 2015) is 5.5%, which is 2.7 percentage points higher than that for loans above e1 million and 1.8 percentage points higher than that for loans between e0.25 million and e1 million. Figure 27. Interest rates on new loans to NFCs (3-month moving average), Ireland, January March 2015 Figure 28 presents the mean interest rate between October 2014 and March 2015 on new loans to NFCs for origination values up to and including e0.25 million (proxy for SME lending). 20 The mean SME interest rate in Ireland (5.5%) is the highest for this group of countries, and is almost 2 percentage points higher than the euro area average (3.6%). Interest rates are, in general, higher in countries with a larger share of non-performing loans. For example, the previous SME Market Report (Box1) showed that SME default rates are highest in Cyprus, Slovenia, Ireland, Greece, Italy, Spain and Portugal (as of end of 2013). Figure 28. Mean interest rate (October March 2015) on SME loans, euro area 19 In this section, interest rates are for new business loans (all maturities) and exclude revolving loans and overdrafts, convenience and extended credit card debt. Interest rate data for loans below e0.25 million are unavailable pre The large reduction in early 2015 is due to a significant drop in February rates. This was the result of a very large issuance of loans at low rates by one bank. 20 Data for Luxembourg in based on one data point (February). The remaining euro area countries are excluded due to missing data

17 Figure 29. Difference between interest rates on small and large NFC loans, Ireland and euro area (3-month moving average), August March Figure 29 displays the difference between interest rates for SMEs (on loans below e0.25 million) and large enterprises (on loans above e1 million). These data are presented for Ireland and, for consistency with Section 4, two sets of euro area countries EU1 and EU2. 21 The interest rate differential is high in Ireland, and ranges from 2.8-3% during The corresponding figures for EU1 and EU2 are % and % respectively. Figure 30. New lending to SMEs as a proportion of domestic demand, Q Q Figure 30 presents the ratio of new SME lending to domestic demand for Ireland and the euro area. Lending flow data are for new NFC loans on amounts up to and including e1 million. 22 Between 2006 and 2009, this ratio ranged from 10-11% in both Ireland and the euro area. Since then, however, large declines are evident, particularly in Ireland. The latest data show that new lending to domestic demand is currently 2.6% (average since Q1 2013), compared to 7% in the euro area. Other Member States with current ratios less than 5% include Lithuania (1%), Slovakia (1.8%), France (3.4%), Finland (3.7%) Austria (4.5%) and Germany (4.5%). 21 This figure is created by first calculating the three-month moving average for the two interest rate series in each country. The data presented is then the difference between these two moving averages, by month. For the comparison country groupings (EU1 and EU2), a direct unweighted mean is calculated. These averages exclude Belgium and Greece due to missing data. 22 This higher loan threshold is chosen as lending data for loans on amounts up to e0.25 million are not available pre Quarterly domestic demand data are downloaded from Eurostat and are at current market prices and non-seasonally adjusted. Monthly new lending data are aggregated to quarterly for comparison. Euro area aggregates for new lending and domestic demand are available from the corresponding data sources (ECB and Eurostat). Percentiles are calculated using ratios for Austria, Belgium, Germany, Estonia, Spain, Finland, France, Ireland, Italy Lithuania, The Netherlands, Portugal, Slovenia and Slovakia. The remaining euro area countries are excluded due to non-availability of data.

18 6 Credit Market Concentration 18 The concentration of SME lending markets is measured using bank-level data on SME outstanding balances ( stock ) and gross new lending ( flow ). Figure 31 reports the movement in the Herfindahl-Hirschman index, which measures the concentration of lending stocks and flows for non-financial, non-property-related lending. 23 Since the last report (data up to Q3 2014), there has been a decrease in the concentration of lending flows, implying that new lending has become more evenly distributed across banks. Lending stock concentration has increased slightly. Figure 31. Herfindahl-Hirschman Index for Non- Financial, non-property-related SME lending, Q Q The Herfindahl-Hirschman index is calculated as the sum of the squared market shares (by bank).

19 Box 1: ECB Targeted Longer-Term Refinancing Operations A defining feature and consequence of the financial crisis has been the declining credit volumes to the real economy. Figure 30 shows that new lending to SMEs has declined considerably in the euro area since Much debate has focused on the knock-on effects of low lending volumes on growth and employment, and policy mechanisms aimed at reversing these trends. Against this backdrop, the ECB has commenced a series of eight Targeted Longer-Term Refinancing Operations (TLTROs), which are intended to increase lending to the real economy. The operations have a maturity of up to four years, with an early repayment requirement for those banks who have not met their lending benchmark by September In the initial two TLTROs (September and December 2014), participating banks could borrow up to 7% of the value of their outstanding loans to the non-financial private sector as of end-april 2014 (excluding loans to households for house purchases). In the remaining six TLTRO allotments, which take place quarterly between March 2015 and June 2016, cumulative borrowings are subject to the bank s level of lending activity to the real economy between May 2014 and the respective allotment month. Specifically, banks will be able to borrow up to three times their level of net lending in excess of their lending benchmark, where each bank s benchmark is a function of average monthly net lending in the 12 months up to April To date, the ECB has allotted e384bn of liquidity over the first four operations. Take-up in the first two operations was considered low, 24 however the third and fourth operation have been at the upper end of market expectations. Analysts are attributing higher borrowings to the change in the cost of liquidity, which will now be fixed at the refinancing rate on the day of each operation. Prior to this, the ECB applied a 10bps spread above the refinancing rate. The increased take-up in the latest rounds of TLTRO can be partly attributed to recent improvement in Eurozone conditions. 25 Market intelligence appears to suggest that borrowings in the first three operations were heavily concentrated amongst counterpartys in Italy (e93bn), Spain (e65bn) and France (e69bn), while estimates show low levels of borrowing by Irish counterparties (less than e5bn). 26 In the latest operation (TLTRO 4), which settled on 24 June, 128 counterparties bid for e73.8bn of liquidity. The take-up was broadly in line with market forecasts (Bloomberg estimate e60-80bn). Individual country estimates for TLTRO 4 are not available at the time of writing. While it is too early for economic analysis to have ascertained whether the TLTRO operations have been effective in achieving their aims, previous evidence from LTROs and VLTROs (very long-term refinancing operations) in 2012 is encouraging. Darracq-Paries and De Santis (2013) find that VLTROs were positively associated with credit supply across the euro area in Gambacorta et al. (2014) find that increases in central bank balance sheets across a range of developed economies have been associated with temporary increases in output and consumer prices, suggesting that unconventional monetary policies such as the TLTRO have had some success since the crisis Financial Times (2014) Europe s banks to determine success or failure of ECB plan. [online] Available at: [Accessed 02 July 2014]. 25 As reflected by April s Bank Lending Survey and growth in M3 (ECB) monetary aggregate. 26 Barclays Bank PLC. (2015) The ECB s TLTRO 4.0. [online] Barclays Bank PLC. 28 Darracq-Paries, M. and De Santis, R. (2013). A Non-Standard Monetary Policy Shock: The ECB s 3-year LTROs and the Shift in Credit Supply, Working Paper Series, European Central Bank, No Gambacorta, L., B. Hofmann and G. Peersman (2014) The Effectiveness of Unconventional Monetary Policy at the Zero Lower Bound: A Cross-Country Analysis, Journal of Money, Credit and Banking, Volume 46, Issue 4, pages

20 Box 2: The Use of Personal Guarantees in Irish SME Lending Recent research carried out at the Central Bank of Ireland uses the Department of Finance RED C SME Credit Demand Survey to explore the determinants of Personal Guarantee (PG) usage in SME bank lending. 29 It is hypothesised that the bank s decision to impose a PG is higher where borrowers are observably more risky, where information asymmetries are more prevalent and where Loss Given Default (LGD) is higher. For borrower risk, the financial performance of the firm and the level of product innovation are explored it is argued that firms engaging in new products/services are riskier than firms trading on existing (and therefore tested) market activities. It is suggested that smaller and younger firms, with higher degrees of informational opaqueness, are more likely to be asked to provide a PG (using the number of employees and the volume of turnover as proxies for the former). On LGD, it is hypothesised that banks will be more likely to impose PGs for higher loan values (with higher LGDs) so that they can recover larger shares of outstanding balances in the event of default. The authors also explore whether PGs and other forms of more traditional and tangible collateral, such as land, buildings and machinery, are complements or substitutes. Figure 32. Predicted probability of personal guarantees by employee numbers 20 Predicted Probability of Personal Guarantee Number of Employees Predicted Value 95 % CI 95 % CI The statistical analysis confirms the majority of these hypotheses. SMEs that introduced new or improved products or services are 11 percentage points (PPs) more likely to have a PG, a large increase relative to the mean (33%). Furthermore, making a profit or breaking even decreases the probability of PG use by 9 and 12 PPs (compared to SMEs that made a loss). The effects of firm size and age are also statistically significant adding ten employees or increasing age by ten years both reduce the probability of PG use by about one PP (see Figure 32 for the effects of employee numbers). PG use also increases with the level of finance requested the results show that increasing the loan amount from e100,000 to e250,000 (about one standard deviation) increases the probability of PG use from 33% to 39%. Finally, the authors show that PGs and other forms of collateral are highly complementary, with the PG probability almost doubling for firms which have other types of collateral. 29 Carroll, James, Fergal McCann, and Conor O Toole (2015) The use of personal guarantees in Irish SME lending, Economic Letters 06/EL/15, Central Bank of Ireland

21 Box 3: The SME Supporting Factor In an effort to increase lending flows to SMEs across the EU, Article 501 of the Capital Requirement Regulation (CRR) No. 575/2013 (European Commission) introduced a reduction in capital requirements for SME lending from January Specifically, this Supporting Factor (SF) resulted in the capital requirements for credit risk on exposures to SMEs being multiplied by a factor of As stated in recital 44 of the CRR, credit institutions should use this capital relief for the exclusive purpose of providing an adequate flow of credit to SMEs established in the Union. The SF is applicable to corporate exposures, retail exposures and exposures secured by immovable property, and on amounts up to e1.5 million (total amount owed to the credit institution). The SME definition applied in the regulation refers only to firm turnover (less than e50 million). To date, the only empirical research on the impact of the SF comes from the Bank of Spain, where the reduction in capital requirements came into effect three months earlier (from October 2013). 28 Their results show that the growth in SME lending is significantly higher than that of larger firms (who are not subject to the SF) since the regulation came into effect depending on the methodology used, the relative growth in SME lending in December 2013 is between 5.8% and 7.9% higher than larger firms Bank of Spain (2014), Financial Stability Report, 05/2014

22 Appendix 1: Data Sources Information from the following sources is used: Outstanding balance and gross new lending data from the Central Bank of Ireland aggregate Credit, Money and Banking statistics to 2014 Q4. Red C SME Credit Demand Survey, April 2011 to March This nationally representative survey of 1,500 Irish SMEs is carried out on behalf of the Department of Finance on a six-monthly basis, and seeks information on a range of economic and financial factors including firms demand for credit, their success in applying for credit, their trading performance and their views on Government interventions in the SME credit market. European Central Bank (ECB) / European Commission (EC) Survey on the Access to Finance of Small and Medium Enterprises (SAFE), April 2012 to March The Irish component of this European survey contains information for 500 SMEs. The cross-country nature of the survey allows credit conditions faced by Irish SMEs to be placed in an international context. In this report, Ireland is compared to two groups of EU countries: EU2 is comprised of Portugal, Spain, Italy and Greece while EU1 is comprised of Austria, Germany, Belgium, Finland, The Netherlands and France. Central Bank of Ireland loan-level data at December This data set provides information on a wide range of loan characteristics including outstanding balances, sector of activity and loan repayment for the population of enterprise loans outstanding at Allied Irish Banks, Bank of Ireland and Permanent TSB. Default is defined as loans greater than 90 days past due, or deemed unlikely to repay without giving up collateral (Basel II). Monthly euro area interest rates and new lending data to non-financial corporations are based on the ECB s Monetary and Financial Statistics (MFI interest rates). These data are for loans other than revolving loans and overdrafts, convenience and extended credit card debt (all maturities). Herfindahl-Hirschman Indices are calculated using the bank-level lending data used to compile the Central Bank of Ireland s quarterly Credit, Money and Banking statistics. 22 Appendix 2: Classification of SMEs For the purposes of the Central Bank of Ireland aggregate statistical series and the Red C survey data, an SME counterparty is defined as any entity engaged in an economic activity, irrespective of legal form (i.e. corporation, partnership, sole-trader, etc.), which employs fewer than 250 persons and whose annual turnover does not exceed e50 million or whose annual balance sheet does not exceed e43 million. This is the standard EU definition of an SME, and is consistent with that applied in the Code of Conduct on SME Lending and by the Credit Review Office. In the SAFE survey data, SMEs are defined solely by their employment size. Three categories of SME are analysed: Micro firms, with less than 10 employees, Small firms with 10 to 49 employees, while Medium firms are those with 50 to 249 employees. All firms with more than 250 employees are considered to be Large firms and are removed from the analysis. The Central Bank of Ireland loan-level data do not contain the relevant information on borrowing firms to define SMEs in a similar fashion. Rather, SMEs are separated from Large borrowers in the data in a manner similar to that used by the current EBA/SSM Asset Quality Review. All firms whose exposures are managed in retail and business banking units of the subject banks are modelled as SMEs, while all exposures managed in corporate banking divisions are considered to be Large firms and excluded from the analysis. Financial Stability Division Central Bank of Ireland