SMALL AND MEDIUM-SIZED ENTERPRISES' ACCESS TO FINANCE

EUROPEAN SEMESTER THEMATIC FICHE SMALL AND MEDIUM-SIZED ENTERPRISES' ACCESS TO FINANCE Thematic fiches are supporting background documents prepared by the services of the Commission in the context of the European Semester of economic policy coordination. They do not necessarily represent the official position of the Institution. 1. Introduction Access to finance is key to business development. Investment and innovation are not possible without adequate financing. A difficulty in getting finance is one of the main obstructions to the growth of many businesses, particularly small and medium sized enterprises (SMEs). Financial flows to SMEs are increasing but remain subdued. Access to finance is still perceived as an important problem by several SMEs 1. Comparing different types of enterprises, micro-enterprises and more innovative businesses in particular consider their financing as the most pressing problem 2. Aside from this, important differences in financing conditions for SMEs between Member States continue to exist. Member States differ significantly with regard to their financial intermediation models. This diversity is reflected in the relative importance of various funding sources used by companies as well as the level of development of various types of financial institutions, e.g. banks, investment funds, insurance and pension funds; and segments of financial markets such as stock exchange, bond market, securitisation (see annex). 1 In the latest Survey on the access to finance of enterprises (SAFE) in euro area countries (June ), access to finance was considered the most important problem by 34% of SMEs in Greece, 15% in Ireland and 15% in the Netherlands, in contrast with only 7% of SMEs in Germany and Austria. In the latest SAFE survey covering all Member States (November 2014), access to finance was cited as the most pressing problem in Cyprus, Greece and Slovenia; and as the least pressing in Sweden, the Czech Republic and Denmark. Source: Survey on the access to finance of enterprises (SAFE), European Commission, European Central Bank. 2 Source: Survey on the access to finance of enterprises (SAFE) 2014, European Commission, European Central Bank. 1

2. Identification of challenges 2.1 Funding sources for companies Bank loans constitute the main source of external funding for corporations in the majority of Member States (Chart 1). Cypriot and Greek companies are most reliant on bank loans, which account for more than half their liabilities. In both countries, securities markets play a minor role in corporate funding. In many Member States, the share of bank loans ranges between 30% and 50% of the balance sheet. Finally, three groups of countries with a relatively low share of bank financing can be distinguished. The first includes large and developed capital markets: the United Kingdom, France and Germany. A large market creates the opportunity for corporate expansion and, the bigger a firm, the greater role can be played by the stock market in the companies financing as opposed to smaller companies which need to rely more on bank loans. Listed shares are also an important source of funding for corporations in the Nordic Member States: Finland, Sweden and Denmark, exceeding 20% of the balance sheet. The third group of countries with less dependence on bank credit includes Slovakia, Lithuania, Estonia and Czech Republic and Poland. In these markets in Central and Eastern Europe, companies rely to a bigger extent on own resources (e.g. retained profits), being part of their equity. Chart 1: Loans to non-financial corporations in the euro area (EUR billion, quarterly data) Source: Eurostat Debt securities play a relatively minor role in the funding of European corporations. France stands out with a 10% share of bonds on the corporate balance sheet, followed by the United Kingdom, Portugal, Austria and Finland. In some countries, corporate bonds are almost non-existent, such as Greece, Romania, Lithuania and Cyprus. This suggests that some obstacles may be hindering the development of these markets. In a few countries the role of trade credit is particularly important. It accounts for almost 20 % of corporate sector liabilities in Malta and Slovakia and is also high in Lithuania, Latvia, the Czech Republic and Slovenia. 2

2.2 Bank lending Bank lending remains the most important source of external financing for SMEs 3 in the EU and the second one for large corporations 4. Furthermore, SMEs have few alternatives to it since they cannot easily access capital markets directly. Over the last year there has been an overall improvement in bank financing conditions and loans are increasing (see Chart 1). Bank lending rates have been trending downwards and maturities have increased. On average, SMEs perceive a significant improvement in the availability of bank financing. Chart 1: Loans to non-financial corporations in the euro area (EUR billion, quarterly data) 80 60 40 20 0-20 -40-60 Loan flows to non-fin. corporations ( billion) Loans flows to non fin. Corp. Bank Lending conditions over the previous 3 months Balance of opinion on lending conditions 20 10 0-10 -20-30 -40-50 -60-70 -80 Source: ECB/Commission Yet SMEs consider that collateral requirements imposed by banks remain high. The difficulties of accessing bank loans are particularly affecting smaller and younger companies. Also, rejection rates remain high in some euro area countries such as the Netherlands (23.5%), Greece (21.5%) and Ireland (18.7%). In addition to the problem of loan applications being rejected, some businesses receive less financing than requested or decline loan offers due to their high costs and/or tight conditions. As a result, over a quarter of SMEs do not get most of the financing they ask for from their banks (see Chart 2). 3 Bank loans remain the primary form of external financing for 62% of SMEs. Cf. SAFE 2014, European Commission, European Central Bank. 4 Behind leasing and factoring. 3

Chart 2: SMEs not receiving most of the amount of bank loan requested (as % of total SMEs requesting bank loans) 5 Source: ECB/Commission From a cross-country perspective, financial markets in the euro area progressed steadily towards integration in the years following the introduction of the single currency. This was reflected in, among other things, a convergence of interest rates for private sector loans. However, economic fundamentals were increasingly diverging during that period and significant macroeconomic imbalances were built up. With the start of the crisis, market perceptions were adjusted and price trends in the banking sector and financial markets started to diverge across national borders. These divergences separate countries on the basis of their perceived capacity to cope with a banking crisis. Although the level of fragmentation has recently diminished, it remains very high. Bank lending rates now show less dispersion across Member States, but significant spreads remain (see Chart 3). Chart 3: 7.5% Interest rates for one-year loans up to EUR 1 million DE ES FR IT EA 6.5% 5.5% 4.5% 3.5% 2.5% 1.5% 2003 2004 2005 Source: ECB/Commission 2006 2007 2008 2009 As shown in chart 4, interest rates for one-year loans up to EUR 1 million of over 4.5% are reported in Portugal, Cyprus, Ireland, Greece, and Slovakia, while SMEs in France, Belgium, Luxembourg and Austria are reporting rates close 2%. Also, the data shows that financing 2011 2012 2013 2014 5 Source: Survey on the access to finance of enterprises (SAFE) 2014, European Commission, European Central Bank. 4

conditions remain tighter for SMEs than for larger firms, as reflected in the higher interest rates paid by the former. Chart 4: Interest rates for one-year loans 6 7% SMEs Large entreprises 6% 5% 4% 3% 2% 1% 0% FR BE LU AT LT EA DE IT ES NL EE MT SI FI LV SK PT MT IE EL Source: ECB/Commission 2.3 Non-bank financing There has been an increase in the issuance of corporate bonds 7, partly reflecting a favourable market environment due to lower interest rates. Yet bonds have mainly been issued by large firms and have been concentrated in larger markets. Equity financing is essential for innovative firms that have the potential for rapid growth and are willing to accept outside equity investors. These firms are in a small minority, but have the potential to grow into large companies. Overall, equity financing is used by 3 % of European SMEs. Innovative SMEs use equity financing more often than non-innovative enterprises 8. The absence of an equity investment culture, differences in information between companies and investors, a fragmented market and high costs resulting from these deficiencies seem to be among the main reasons for a lower level of venture capital funds in some Member States. Despite some improvement, activity levels in this field are still very low. At EU level, in 2014, venture capital fundraising amounted to 4.1bn, a decrease of 12% compared to 2013. The amount invested by these funds (EUR 3.6 bn) increased on a yearly basis by 6%. In 2014 around 90% of all venture capital investment was concentrated in eight Member States 9. In relative terms, as a percentage of GDP, there are also significant differences across countries (see Chart 5). The venture capital markets are more developed in Sweden, Finland, Ireland and the United Kingdom. Trade sale, write-off and sale of quoted equity were the most prominent exit routes for venture capital. 10 6 Loans up to EUR 250.000 are used as proxy for loans to SMEs, and those over EUR 1 million a proxy for loans to large enterprises. 7 Cf. Financial integration in Europe, European Central Bank. 8 4% of innovative versus 2% of non-innovative enterprises. Source: Survey on the access to finance of enterprises (SAFE) 2014, European Commission, European Central Bank. 9 The United Kingdom, Germany, France, Sweden, Netherlands, Finland, Belgium and Spain. 10 Source for figures on venture capital: Invest Europe Yearbook 2014, Invest Europe. 5

Chart 5: Venture capital as % of GDP (2013) 11 0.07% 0.06% 0.05% 0.04% 0.03% 0.02% 0.01% 0.00% SE FI IE UK HU FR PT BE DK NL DE AT ES LU CZ BG PL RO IT EL Source: Invest Europe Crowdfunding (both securities-based and lending-based) is also emerging as an important complement to other sources of finance. Although its size is still low compared to traditional forms of financing, crowdfunding is rapidly growing. However, the market is concentrated in a few countries, with the United Kingdom playing a pivotal role. While the issuance of corporate bonds has increased, in particular in the high-yield segment, the increase is concentrated in countries with a more stable flow of bank loans. Only few countries facilitate issuance of SME-bonds, mainly through national or regional stock exchanges. 2.4 Payment times of public authorities Late payments in commercial transactions can also cause financial problems and uncertainty for suppliers, particularly small businesses. In the public sector, the average time it takes for public authorities to pay their bills has improved overall between and (see Chart 6). Chart 6: 200 Payment times for public authorities, duration/ delays in days Contract (days) Delay (days) 150 100 The Late Payments Directive foresees a maximum duration of 30 days 50 0 2012 2012 2013 2012 2014 LT DE EE FI SK UK LV RO DK IE CZ AT NL SE PL SI HU HR EL BG FR BE CY PT ES IT Source: European payment index, Intrum Justitia. Note: No data available for for Croatia and Cyprus (2014 data used in chart). No data available for for Romania, Slovenia and Bulgaria (2012 used in chart) and for Croatia (2013 data used in chart). 11 The graph shows the latest data available for Estonia, Latvia, Lithuania, Slovenia and the Slovak Republic, which corresponds to 2011. No data was available for Cyprus, Croatia and Malta. 6

3. Identification of policy levers to address the challenges Member States have taken several policy measures to enhance SMEs' access to finance, with varying results. Most of the regulatory activity has taken place in those countries where bank lending to SMEs worsened more during the crisis. The most widespread measure has been enhancing and strengthening loan guarantee systems, mainly through broadening their scope and increasing the allocation of public funds into such guarantee schemes. Other and less widespread policy measures at national level have addressed: further developing corporate bond markets and alternative markets for SMEs; facilitating the securitisation of SME loans; easing the access and transfer of financial information; developing a regulatory framework for crowdfunding; and enhancing the public venture capital sector. In parallel, promotional financial institutions are being set up in various Member States. 12 4. Cross examination of policy state of play 13 At European level, the Capital Markets Union will help bring a more diverse supply of finance to SMEs by complementing bank financing with deeper, more developed capital markets. Relevant measures like building a pan-european approach to better connect SMEs with a wide range of funding sources and facilitating securitisation should support national action to improve access to finance for SMEs as outlined above. Other measures aim at creating the appropriate regulatory frameworks for innovative sources of funding to grow, such as crowdfunding, private placements and loan originating funds, whilst safeguarding investor protection and financial stability. The Commission will also bring forward a comprehensive package of measures to support venture capital and risk capital financing in the EU, including catalysing private investments using EU resources through a pan-european fundsof-funds, regulatory reform, and the promotion of best practice on tax incentives. Furthermore, the new European Fund for Strategic Investments (EFSI) has been set up and will allocate a quarter of its resources to support risk finance for SMEs and small mid-cap companies. This should help SMEs overcome capital shortages by providing higher amounts of equity and loan finance. Financial intermediaries lending to SMEs and small midcaps can benefit from guarantees of the European Investment Fund (EIF) for loan portfolios or the securitisation of loans. The programme for the Competitiveness of Enterprises and Small and Medium-sized Enterprises (COSME) is improving access to finance for SMEs through two financial instruments that have been available since August 2014. COSME financial instruments operate in conjunction with those of the Horizon 2020 Framework Programme for Research and Innovation: InnovFin EU Finance for Innovators. Date: 26.11. 12 For further details, please refer to the Country Report of each Member State, http://ec.europa.eu/europe2020/making-it-happen/country-specific-recommendations/index_en.htm. See also the SME Performance Review tool developed by the European Commission, which monitors and assesses countries' progress in implementing the Small Business Act, including on access to finance, on a yearly basis. 13 "Action Plan on Building a Capital Markets Union", COM() 468 7

Annex: Financial intermediation in the Member States Chart 8: Intermediation through financial institutions and financial markets as % of GDP (2013, 2014 or ) Via institutions Via markets % of GDP Banks Investment Insurance Pension Listed shares of Private Venture IC&PF Bonds of NFC Securitisation funds companies funds NFC equity capital (assets) (assets) (assets) (assets) (assets) (capitalisation) (outstanding) (outstanding) (investment) (investment) BE 254,7 26,5 77,8 5,0 82,8 58,1 9,9 17,0 0,239 0,028 BG 108,6 3,4 : : 10,5 7,1 3,1-0,006 0,006 CZ 120,3 2,7 : : 18,2 10,4 7,9-0,194 0,006 DK 291,3 101,6 108,8 75,1 183,9 82,7 9,6 0,1 0,486 0,026 DE 242,7 53,4 60,0 16,3 76,1 43,8 4,4 2,3 0,247 0,023 EE 108,8 13,9 : : 15,4 8,6 7,0 - - - IE 519,5 642,4 : : 174,2 186,4 1,0 18,2 0,274 0,049 EL 199,2 2,3 7,9 0,2 8,1 13,3 0,9 13,6 0,000 0,000 ES 246,0 20,5 : : 38,0 36,5 2,0 15,6 0,151 0,009 FR 273,6 41,6 97,1 : 0,0 65,2 24,2 3,2 0,395 0,030 HR 129,9 1,6 8,8 18,7 27,5 30,4 4,8 - - - IT 184,6 11,1 : : 41,1 18,8 8,1 9,4 0,113 0,002 CY 461,9 14,0 : : 37,7 7,4 5,5 - - - LV 123,3 1,5 4,5 8,3 12,8 3,6 0,7 0,0 - - LT 70,2 0,7 2,7 4,6 7,3 9,4 0,0 - - - LU 1865,7 5287,3 300,3 2,5 302,8 110,5 42,0-0,057 0,009 HU 97,2 11,8 8,3 4,3 12,6 8,3 2,0-0,165 0,031 MT 669,1 82,4 132,5 0,0 132,5 10,9 4,3 - - - NL 307,3 89,0 62,1 154,3 213,9 47,7 11,7 36,8 0,472 0,026 AT 213,1 48,9 32,5 5,8 38,3 18,8 11,6 0,6 0,088 0,019 PL 82,1 12,5 : : 27,8 17,3 4,8 0,1 0,061 0,005 PT 233,8 8,5 : : 45,1 22,6 19,8 20,0 0,153 0,029 RO 60,4 5,6 2,4 3,8 6,2 9,3 0,1-0,052 0,004 SI 107,5 5,9 : : 24,0 14,2 2,9 - - - SK 78,1 5,2 8,4 9,7 18,1 2,7 4,3 - - - FI 265,3 38,4 32,2 1,8 34,0 68,2 15,6 0,5 0,348 0,060 SE 256,3 70,0 97,3 24,9 122,1 88,1 20,2-0,330 0,066 UK 571,1 : : : 214,3 74,4 22,7 14,3 0,424 0,038 Source: Eurostat, ECB, Securities Industry and Financial Markets Association (SIFMA), European Private Equity & Venture Capital Association (EVCA) Banks are the largest financial intermediaries in all Member States, although their relative importance varies significantly from one country to another. In most EU countries, total assets of the banking sector represent twice to four times national GDP. However, this ratio is much higher in Malta, Ireland and Cyprus, which underlies the importance of the banking sector in these countries. Luxembourg is an outlier, with total bank assets exceeding GDP up to twenty times. On the other hand, in the still converging financial markets of Central and Eastern Europe, total assets of the banking sector are typically about the same size as national GDP, the lowest level of banking penetration being recorded in Romania (60% of GDP), Lithuania (70%) and Slovakia (78%). While loans typically represent the bulk of the banking assets, most banks also invest in capital markets. Insurance companies and pension funds are the key institutional investors intermediating funds from households to capital markets. Great diversity in the relative importance of these institutions in various markets can be observed. In Luxembourg, the assets of insurance companies amount to 300% of its GDP. Other countries with a sizable insurance sector are Malta, Denmark, France, Sweden and Belgium. On the other hand, countries in Central and Eastern Europe typically have smaller insurance sectors. Regarding pension funds, the Netherlands stands out with total assets amounting to 154% of GDP. Except for Denmark, where pension funds' assets represent 75% of GDP, this ratio typically does not exceed 20% in other Member States. 8

Diversity is also characteristic of the European investment fund sector. Luxembourg and Ireland, which are the two main EU hubs for fund registration, are the outliers: the assets held by investment funds represent 53 and 6.4 times their national GDP, respectively. In other EU Member States, the size of the asset portfolio held by investment funds ranges between 20% and 100% of GDP in countries with significantly developed capital markets, while it is below 15% of GDP in all Central and Eastern Europe countries. The investment funds sector is particularly underdeveloped in Lithuania, Latvia, Croatia Greece, the Czech Republic, and Bulgaria, where investment funds' assets represent less than 3.5% of GDP. The size of the stock market also varies greatly from one Member State to another. The capitalisation of publicly-listed non-financial companies (NFC) relative to GDP of the country where the NFC is registered is highest in Ireland (190%) and Luxembourg (110%). Public equity markets are also large in the UK, Nordic countries, France, Belgium and Germany. In all Central and Eastern Europe countries except Poland and the Czech Republic, public equity shares of NFCs represent less than 10% of GDP. In all EU Member States, corporate bond markets are smaller than stock markets. However, national differences still prevail. Luxembourg has the most developed bond market relative to its size, with the value of outstanding bonds reaching 42% of GDP. The size of the national bond capital market exceeds 15% of GDP in France, UK, Sweden, Portugal and Finland. On the other side of the spectrum, several Member States feature very small corporate bond markets, in particular Romania, Latvia and Lithuania (below 1%), but also Ireland, Greece, Estonia, Hungary and Spain. The level of development of securitisation indicates the degree to which financial intermediaries (primarily banks) use capital markets to fund their portfolios. It also varies greatly between Member States. Although securitisation is predominantly used for mortgage and consumer products, some corporate loans and bonds are also used as underlying assets. The Netherlands has the largest securitisation market (37% of GDP), with the bulk of the collateral being mortgage loans. Some countries also have relatively developed securitisation markets, with stocks of securitised assets representing between 15% and 20% of GDP (Portugal, Ireland, Spain, UK). In some other large European countries, even though the amount of securitised assets outstanding is relatively low as a percentage of GDP, the securitisation market is also sizable in absolute numbers (France, Germany, Italy). In most other Member States, the value of the outstanding securitised assets relative to the size of the economy is very small. Private equity and venture capital, even if limited in all EU Member States, are important sources of funding, especially for higher risk and innovative projects. They can still be regarded as niche solutions compared to traditional financing venues. Taking all types of private equity investment into consideration, private equity activity is highest in the most developed capital markets (the large Member States, Benelux, the Nordic countries), but even in these countries it remains below 0.5% of GDP. Venture capital, used for start-ups and more risky undertakings, constitutes a small fraction of private equity. This type of financing is most developed in Sweden (0.07% of GDP), Finland, Ireland and the UK. 9