A presentation by Martin D. Shanahan, Chief Executive, Forfás to the Joint Committee on Jobs, Enterprise and Innovation on Tuesday 27 th May 2014 on the matter of Access to Finance for SMEs Executive Summary Forfás is Ireland s policy advisory board for enterprise, trade, science, technology and innovation. Forfás works closely with our sister enterprise development agencies (IDA Ireland, Enterprise Ireland and Science Foundation Ireland), undertakes evidence-based research and analysis, and provides policy advice to the Minister and Department of Jobs, Enterprise and Innovation (DJEI) and Government in a range of policy areas from an enterprise perspective, including advice on access to finance. SMEs dominate our economy almost 7 out of ten employees work in SMEs. It is essential that viable SME have access to sufficient funding to run and grow their businesses. SMEs are also diverse in terms of their recent performance and financing needs. Younger firms, who are likely to account for a disproportionate share of employment growth, are more reliant on external finance than internal finance. Based on the ECB s SAFE survey, we can see that the financial performance of Irish SMEs is starting to show signs of improvement when compared to recent years and other European countries. Turnover is growing, indebtedness is falling although, in net terms, SMEs are not yet reporting increased profits. ECB data suggest that while a high share of Irish SMEs regard access to finance as a pressing issue, demand for bank funding is relatively weak. Demand is also more focused on short term finance (e.g. overdrafts) for working capital rather than longer term capital for productive investment. For those SMEs that apply for bank funding, 66% of euro area SMEs and 38% of Irish SMEs reported that they had received the full amount they had applied for. Taking a broad measure of financial obstacles 1 in the banking sector, the ECB survey finds that a relatively high share of SMEs in Ireland (19%) still face significant financing difficulties versus an EU average of 12%. Examining Irish data highlights that over the course of the last six months credit advanced to the resident non-financial corporations (NFC) sector (enterprise sector) has declined at an average annual rate of 5.1 per cent, to end-january 2014. The decline in credit advanced to SMEs was most evident in the Hotels & Restaurants, Business & Administrative Services, and Manufacturing sectors. Irish data also confirms that demand for credit remains relatively weak. The latest data also indicates that a higher percentage of businesses believe the banks are open for business (47% compared to 39% in September 2012) and that bank refusal rates for loans are falling (19% compared to a 23% decline rate recorded a year ago). The cost of finance also continues to be an issue for Irish enterprises. Cost competitiveness may weaken further as the banks need to rebuild profitability and as competition has reduced. 1 Adding together the percentages of SMEs reporting rejections of loan applications, loan applications for which only a limited amount was granted, and loan applications which were rejected by the SME because of too high borrowing costs, as well as the percentage of SMEs which did not apply for a loan for fear of rejection. 1
It is not easy to disentangle supply and demand effects. Research from the ESRI highlights that credit constraints affect a small minority of SMEs (between 4 and 11 percent). Mirroring the findings presented earlier, they noted that most SMEs do not apply for funding because they do not need it and that those facing credit constraints are mainly young, small firms and firms that have a domestic customer base and a debt overhang. In addition, the ESRI question the extent to which the financial system can provide adequate funding for firms once aggregate demand recovers. Bank finance, while important is just one source of finance. Since 2008, we have seen strong growth in the use of share and other equity and the use of other accounts receivable. The initiatives on bank lending are now being complemented by a greater focus on non-bank sources of finance, to both increase the funding options and to ensure that SMEs have the necessary equity to get bank credit. A number of State Agencies provide funding and other supports to businesses, particularly small businesses including the Local Enterprise Boards, Enterprise Ireland, Bord Iascaigh Mhara, Fáilte Ireland and Údarás na Gaeltachta. A number of additional supports were developed to help business through the economic crisis. There are over 2bn of State supports available in the SME and farming sector, including large supports from Enterprise Ireland and the National Pensions Reserve Fund. The Action Plan for Jobs 2014 sets out a range of additional actions (actions 205 to 224) for implementation before year end. Much has changed in recent years and a wide range of actions are underway to ensure that viable businesses can access funding on acceptable terms and costs. Given the depth of the financial crisis and its legacy impacts on the enterprise sector, the banks and the broader economy, it can be expected that it will take some time before debt levels and funding flows return to normal levels. As noted earlier, it should also be remembered that even during the good times, small innovative export orientated businesses had difficulty accessing appropriate funding. From Forfás s perspectives, some of the key challenges facing Ireland include: There is a continuing need to ensure that the efficacy of measures put in place to improve credit flows through recapitalisation, deleveraging and restructuring of the banks can be assessed and further action taken if required. In this regard, there is a need to continue to monitor bank lending carefully. This is particularly important as the economy returns to growth and demand for funding increases. The State needs to continue to work to ensure that the banking system is aligned with the strategic economic growth targets of the economy. In this regard, a move towards a banking system with a deeper understanding of innovative sectors (e.g. software, telecoms, digital content, medtech and life-sciences) and a pro-active overseas banking network are required in the medium term. More immediately, there needs to be a focus on supporting internationally trading businesses in terms of both the provision of credit and the bank facilities/products (e.g., international invoice discounting, performance bonds and specialised leasing, amongst others). The scaling back of the domestic bank sector and the withdrawal of many foreign banks highlights issues over the levels of competition in the banking sector as the business banking market has become highly concentrated. A particular challenge exists for those SMEs who currently rely on banks who are withdrawing from Ireland. The Programme for Government contains plans to establish a Strategic Investment Bank and its place in the banking landscape and its precise role is under consideration. It will be 2
important that this and other mechanisms put in place address the challenges set out above. Encouraging equity investment represents a mechanism to help some over-indebted but viable businesses to rebalance their balance sheets. Equity begins from the earliest stage of the business life-cycle with friends, family and founders investing at the pre-seed stage to business angels and venture capitalists investing in the seed and start-up phase right up to the latter stages through mechanisms such as trade sales and initial public offerings. Actions are required to support firms to take on equity investments, encourage potential investors to invest and support the development of equity networks/ markets. Given that a Department of Finance review is underway, now is a particularly opportune time to redesign the EIIS/ SCS to ensure that it delivers on its potential to support the funding needs of growing businesses. The State can also support other forms of funding. The Committee recently heard from peer-to-peer lenders and businesses that they have supported. There is strong potential for the State to provide a supporting environment to alternative sources of finance such as these. 3
1. Introduction to Forfás Forfás is Ireland s policy advisory board for enterprise, trade, science, technology and innovation. Forfás works closely with our sister enterprise development agencies (IDA Ireland, Enterprise Ireland and Science Foundation Ireland), undertakes evidence-based research and analysis, and provides policy advice to the Minister and Department of Jobs, Enterprise and Innovation (DJEI) and Government in a range of policy areas from an enterprise perspective. Forfás provides advice on a diverse range of policy areas which impact on enterprise including enterprise development, competitiveness, trade and investment, tax and finance, education & skills and labour market, innovation and R&D, and infrastructure for business. This requires that Forfás works across government departments and agencies. Forfás also manages the work of and provides research and analytical support to the National Competitiveness Council and the Expert Group on Future Skills Needs. Forfás has a key role in developing the annual Action Plan for Jobs and is responsible for implementing some of the actions therein. As part of our agenda, we are active in the access to finance policy area. We have undertaken a number of research projects in recent years and provide ongoing support to DJEI and broader stakeholders through the SME State Bodies Group, which is chaired by the Department of Finance. We also work directly with the development agencies in terms of reviewing the supports they offer companies. Key work includes: The Irish Enterprise Funding Environment, April 2012. A Review of the Equity Investment Landscape in Ireland, January 2013. Participation in the SME State Bodies Group, ongoing. Research support to the Department of Jobs, Enterprise and Innovation, ongoing. Review of Development Agency Programmes, ongoing. This paper relies heavily on data from external sources including the CSO, the Central Bank of Ireland, the ESRI, the ECB s SAFE Survey and the RedC Demand survey. 4
2. SMEs, SME Funding Needs and Performance The section assesses the role of SMEs in the Irish economy, the importance of funding for enterprise and the ramifications of a lack of funding, and assesses the importance of key funding sources for Irish SMEs. Finally, based on survey data from the European Central Bank (SAFE survey), it compares the performance of Irish SMEs to their European peers in terms of their trading performance and funding experience. 2.1 Role of SMEs in the Irish economy 2 SMEs dominate our economy - SMEs account for 99.8% of active enterprises in Ireland. These businesses account for 68.6% of persons employed, 50.1% of turnover and 46.0% of gross value added (GVA). In detail, CSO data indicates that the great majority of enterprises in the business economy (90.8%) are micro-enterprises (i.e. businesses with less than 10 employees). A further 7.7% are other small enterprises while 1.3% are classified as medium sized enterprises. Only 0.2% of enterprises are classified as large (i.e., with greater than 250 persons engaged). SMEs are diverse. SMEs are active in both the domestic market and overseas. A significant minority are also foreign owned. In relation to the 41.1 billion in GVA generated by SMEs in 2011, 39.7% was accounted for by Irish SMEs that were solely engaged with the domestic economy. These locally owned and domestically focused SMEs accounted for 62.0% of the employment in all SMEs. Irish SMEs that engaged in international trade in 2011 accounted for a further 27.6% of GVA while their SME employment share was 27.3%. Foreign-owned SMEs that engaged in international trade accounted for just less than a quarter of GVA, while foreignowned SMEs solely engaged with the domestic economy accounted for the remaining 10.0% of GVA. Irish owned SMEs, particularly those focused on the domestic market, have faced the greatest challenges in recent years as market demand fell. They are also more reliant on the domestic market for funding. Looking at these factors in detail, employment in SMEs for the total business economy fell from 1,045,000 in 2006 to 839,000 in 2011 or to 80.3% of the 2006 level. The sector that was impacted the most was Construction where SME employment in 2011 was only 38.9% of the 2006 level with almost 128,000 job losses. Industry was also impacted quite heavily with SME employment in the sector falling to 78.2% of the 2006 level which corresponds to over 31,000 job losses. The only sector where SME employment increased over this period was in Financial and Insurance activities. 2.2 Importance of Funding Finance is the life-blood of every business. This requirement materialises from the development of a business concept, to setting up a business and through to the growth and expansion stages. Even before the current financial crisis emerged, a number of longstanding issues were evident in the market for funding in Ireland. For example, innovative exporting small and medium sized enterprises traditionally had trouble in accessing external credit finance. The reasons may be that newer technology and business models might not neatly fit into existing lending criteria of financial institutions; a lack of collateral or a lack of track record. 2 Data sourced from the CSO s Business in Ireland, 2011. 5
This is a major challenge as young SMEs play a crucial role in employment growth in our country. Evidence shows a stable and appropriate supply of credit promotes growth, encourages start ups and enables incumbent firms to grow by exploiting trade and investment opportunities. An International Monetary Fund (IMF) working paper indicates that there is a stronger risk that our recovery could be creditless (i.e. the economy could recover while there would be a continuing real fall in credit or zero credit growth) as Ireland experienced an exceptionally strong credit boom, a major property boom and bust cycle, and a major banking crisis, the conditions in which creditless recoveries are most likely to occur 3. Creditless recoveries are on average substantially weaker than normal recoveries and take longer to recover from - output growth is on average one third lower. Therefore, despite the welcome return in economic and employment growth, we must remain alert to the risks of funding shortages particularly as demand for funding grows. In terms of policy actions, the same IMF working paper also notes that during creditless recoveries, policy measures aimed at restoring the banking system will lead to higher growth (e.g. recapitalising banks). However, the lack of credit growth can also result from an overindebted private (non-financial) sector. Even in the presence of relatively healthy banks, the existence of previous debt may inhibit the private sector from accessing credit for potentially profitable investments. In Ireland, problems are arising from both weak demand for credit and weak supply of credit. 2.3 Sources of Funding There are a number of sources of finance for enterprises (see figure 1), which can be categorised as internal and external finance. These are not perfect substitutes due to differences in availability, cost, and other terms and conditions 4. Funding sources vary according to firm characteristics - predominantly firm age, size and sector in which they operate. In terms of internal finance, enterprises rely mostly on owners own resources and finance from friends and family in the early years and on retained profits as the business gets older. In terms of overall financing, younger firms are more reliant on external finance than internal finance. Figure 1: Source of Financing Employed by SME Respondents across Age Categories (%) 3 Abiad et al. (2011) Creditless Recoveries, IMF Working Paper 11/58, 2011. 4 Holton and O Brien (2011) Firms Financing During the Crisis: A Regional Analysis in Central Bank Quarterly Bulletin 01, January 11. 6
Source: Mac an Bhaird (2010), Resourcing Small and Medium Sized Enterprises: A Financial Growth Life Cycle Approach 5. Irish and international experience suggests that in most EU countries, start-ups, very young firms and innovative SMEs, whose technology and business models are not understood by many financial institutions, and lack a track record and collateral against which to raise debt finance, traditionally experience difficulty in accessing external debt finance 6. In summary, Figure 2 presents an overview of the funding environment for indigenous exporting firms. It is important to point out that not all sources are available to all enterprises, as some sources of finances are directed towards incorporated entities. Figure 2: Finance Continuum for Indigenous Exporting Firms Source: Enterprise Ireland (2012) 2.4 Relative Performance of Irish SMEs 7 The European Central Bank s Survey on the Access to Finance of Small and Medium-Sized Enterprises in the Euro Area (October 2013 to March 2014) or SAFE survey provides an overview on the changes in the financial situation, financing needs and access to external financing of small and medium-sized enterprises in the euro area 8. This section addresses these issues in turn. Financial Situation of Irish SMEs The financial performance of Irish SMEs is starting to show signs of improvement when compared to recent years and other European countries. Turnover is growing, indebtedness is falling although, in net terms, SMEs are not yet reporting increased profits. 5 Based on a sample size of 299 out of an eligible population of 702. 6 European Commission (2009) Cyclicality of SME Finance, May 2009. 7 Source: Survey on the access to finance of small and medium-sized enterprises in the euro area, October 2013 to March 2014, April 2014. 8 It should be noted that the survey sample is relatively small. 7
Irish SME turnover is growing. A small net percentage of euro area SMEs reported a reduction in turnover (-2%, compared with -3% in the previous survey period) over the period October 2013 to March 2014. In line with previous survey periods, SMEs in Germany (+45%) contributed positively to turnover developments, while SMEs in Spain (-15%) and particularly Italy (-32%) contributed negatively. Ireland also contributed positively (+16%). Against the background of high corporate indebtedness, deleveraging in the euro area SMEs has continued (a net percentage of -8%). A significant net percentage of Irish SMEs (22%) recorded a reduction in their corporate indebtedness. Across the euro area, SMEs profit dynamics were reported to have improved in the Netherlands, Germany and Austria. By contrast, the worsening in the profit situation was considerable in Greece (-55%), Italy (-54%), Portugal (-38%) and, to lesser extent, Belgium (- 17%). The net percentage of respondents reporting an increase in profits in Ireland was -2%. Financing Needs of Irish SMEs A relatively high share of Irish SMEs (38%) regard access to finance as a very pressing issue. However, a relatively low share of Irish SMEs report an increase in their need for bank finance although Irish SME demand for overdrafts was stronger. In light of this, it is not surprising that the survey finds that finance for working capital is driving the need for external finance in Ireland whereas in the EU, finance for fixed investment is relatively stronger. Across euro area countries, when asked how pressing was access to finance as a problem in their current situation, SMEs in distressed countries said they continued to perceive it as a very pressing problem (giving it 7-10 on a scale of 1-10). Greece (66%) remains the country reporting the highest percentage in this respect, followed by Italy (52%), Spain (45%) and Portugal (43%). In Ireland, 38% of SMEs report it to be a very pressing issue. Access to finance is not regarded as pressing in Finland, the Netherlands, Austria and Germany. At the euro area level, 4% of SMEs reported an increase in their need (demand) for bank loans (marginally lower than in the previous survey round) versus 2% in Ireland. At the euro area level, 7% reported an increased need for bank overdrafts (down from 9% in the previous survey round) versus 11% in Ireland. Fixed investment (11%) and inventory and working capital (9%) remain the two most important factors affecting SMEs need for external financing across the EU. While the need for financing for fixed capital investment in Ireland remains relatively weak (4%), financing for inventory and working capital was strong (13%). Euro area SMEs reported a somewhat higher need for external financing resulting from insufficient availability of internal funds (5%, up from 3%). A higher percentage of Irish firms (10%) noted a need for external financing resulting from insufficient internal funds. Access to External Financing Irish SMEs (-6%), and particularly micro-enterprises (-8%), are still reporting a greater deterioration in the availability of bank loans that than across the EU (-4%). However, the external financing gap, which measures the perceived difference at firm level between the need for external funds (across all channels: bank loans, bank overdrafts, trade credit, and equity and debt securities) and the availability of funds declined in Ireland. After significant declines, Irish SMEs reported a slight increase in bank willingness to lend in the past 6 months, however, relative to other countries, applications for loans remained low in Ireland. A small but significant minority are not applying because of a fear of rejection (13% in Ireland versus an EU average of 6%). For those SMEs that apply, 66% of euro area SMEs and 38% of Irish SMEs reported that they had received the full amount they had applied for. Taking a broad measure of 8
financial obstacles, the ECB survey finds that a relatively high share of SMEs in Ireland (19%) still face significant financing difficulties versus an EU average of 12%. In more detail: In the period from October 2013 to March 2014, fewer euro area SMEs reported a deterioration in the availability of bank loans (-4% in net terms, after -11% in the previous survey round). Among the largest euro area countries, SMEs signalled an improvement in the availability of bank loans in Germany (+5%) and Spain (+16%). In Ireland, 6% of SMEs reported (in net terms) a deterioration in the availability of bank loans with microenterprise reporting a weaker performance (-8%). The external financing gap, which measures the perceived difference at firm level between the need for external funds (across all channels: bank loans, bank overdrafts, trade credit, and equity and debt securities) and the availability of funds declined to 8% from 10% in the previous survey period. SMEs in Germany, Ireland, Spain, Italy and the Netherlands reported a decline in their financing gap compared with the previous survey period, while the net percentage increased significantly in Greece (40% from 28%) and in Austria and Portugal. SMEs in most countries reported smaller deterioration in banks willingness to provide a loan. Italy (-25% after -35%), the Netherlands (-17% after -34%) as well as Belgium (-8% from -19%) all signalled a much lower deterioration. Ireland (3% after -14%) and Finland (1% after - 12%) reported an increase in banks willingness to provide a loan as compared with previous rounds. Applications for loans remained low in Ireland. France remained the country with the highest percentage of SMEs applying for a bank loan (31%), followed by Italy (29%) and Spain (26%), while the figure was lowest in the Netherlands (12%), Ireland (14%) and Greece (15%). 57% of Irish firms did not apply because they have sufficient internal funds. 13% did not apply because of possible rejection (down from 16% in the previous study) which compares poorly to an EU average of 6%. When asked about the actual success of their bank loan applications, SMEs indicated a broadly unchanged situation at the euro area level. 66% of euro area SMEs reported that they had received the full amount they had applied for. In Ireland, 38% of SMEs reported that they were fully successful. 23% of Irish SMEs reported that they applied but were rejected (EU average of 11%), 13% received part of what they wanted (EU average 10%) and 8% of SMEs refused the offer because the cost was too high (EU average 1%). Looking at a more encompassing measure of financing obstacles, (adding together the percentages of SMEs reporting rejections of loan applications, loan applications for which only a limited amount was granted, and loan applications which were rejected by the SME because of too high borrowing costs, as well as the percentage of SMEs which did not apply for a loan for fear of rejection) suggests that 12% (unchanged from the previous survey round) of euro area SMEs have reported that their loan applications were not successful in the period from October 2013 to March 2014. Across countries, the percentage was highest in Greece (26%) and Ireland (19%), followed by Italy (17%) and the Netherlands (15%), and was lowest Finland (6%), Austria and Germany (both 4%). Future Expectations For the six-month period (April to September 2014), euro area SMEs expected, on balance, a slight improvement in the availability of bank loans (1%, after 0% for the period October 2013 to March 2014). SMEs expectations regarding the availability of bank loans during the period from April to September 2014 showed a deterioration in France (-18%, after -11%), whereas expectations improved significantly for SMEs in Spain (13% after 5%) and Ireland (11% after 2%). 9
3. Where are we now? Building on section 2, this section provides a more detailed overview of the supply and demand for funding in Ireland. Firstly, it assesses the supply and demand of bank credit and then reviews the use of other funding sources such as equity, trade creditors, and role of state supports. 3.1 Supply of Credit 9 Central Bank data highlights that the stock of credit has fallen dramatically in Ireland. The banking system in Ireland has continued to contract reflecting the ongoing deleveraging efforts by the Irish-owned credit institutions, as well as the wider retrenchment of foreign banks in Ireland. Total assets of credit institutions operating in Ireland were 728 billion at end-january 2014, a reduction of 15.3 per cent over the previous twelve months. The total assets of the Irish resident banks now stand at half of the 2008 peak. Total assets of the domestic market s banking system (excluding IFSC banks) declined by 13.4 per cent over the twelve months to end-january. Loans to the Irish private sector declined by 6.3 per cent over the year to end-january 2014. The reduction in debt is being driven by the need of the banks to strengthen their balance sheets and by the wider debt dynamics faced by the Irish non-financial private and public sectors, which are undergoing their own process of deleveraging. The stock of loans to the enterprise sector is also declining relative to historical trends and relative to other liabilities. Non-financial corporation (NFC) debt decreased by 5.7 billion during Q3 2013 to 351 billion. This marked the fourth consecutive quarter where debt outstanding declined. The ratio of NFC debt to total liabilities also decreased during the quarter to 37.3 per cent, due to an increase in total liabilities of 8.7 billion, and the drop in debt. The reduction in this indicator was also a result of greater use by NFCs of funding from shares and other equity and other accounts payable. Loans issued by resident credit institutions are an important source of funding for indigenous companies. In particular, this is true for small and medium sized Irish enterprises, which unlike the multinational sector, may not have easy recourse to international banks, alternative marketbased funding or/and have access to capital injections from overseas parent entities. Central Bank data highlights that over the course of the last six months credit advanced to the resident NFC sector has declined at an average annual rate of 5.1 per cent, to end-january 2014. During the preceding six months, the level of credit advanced had fallen by an average of 4.6 per cent. This continued decline in the supply of credit is notable. The monthly net flow of credit to the NFC sector averaged minus 406 million over the last six months to end-january 2014. 9 Based on the Central Bank Quarterly Q2 2014) 10
Term time for loans is also an important issue. While the outstanding amount of loans with an original maturity of under one year, between one and five years, and over five years are all falling, loans with a maturity of between one and five years continued to fall more sharply over the last number of months. While short terms loans are critical to supporting working capital, longer term funding is essential to support investment in productive assets. Finally, sectoral differences are also apparent in SME lending. Credit advanced to non-financial SMEs fell by annual rate of 5.1 per cent at end-december 2013. The decline in credit advanced to SMEs was most evident in the Hotels & Restaurants, Business & Administrative Services, and Manufacturing sectors. New lending drawdowns in the Agriculture sector continued to be strong and accounted for 27 per cent of all new lending to non-financial SMEs in 2013. Notwithstanding this new lending, the Agriculture sector also made net repayments of loans over of 2013. In additional to reviewing the availability of credit, it is also important to consider the cost of credit. The cost of finance also continues to be an issue for Irish enterprises. Cost competitiveness may weaken further as the banks need to rebuild profitability and as the business banking market has become more concentrated. The National Competitiveness Council 10, which Forfás provides research to, had highlighted that: New business interest rates for non-financial corporations are higher in Ireland than in the euro area rates are 31 per cent higher for loans up to 1 million and are 27 per cent higher for loans above 1 million. In November 2013, interest rates in Ireland for revolving loans and overdrafts were 11.5 per cent above the euro area average. With respect to bank charges, according to data from the European Central Bank, 68 per cent of Irish SMEs felt that the costs of financing (other than interest rates i.e. charges, fees and commissions) had increased in the six months prior to September 2013. By comparison, 43 per cent of euro area SMEs felt costs had increased 11. 3.2 Demand for Credit Figure 3 illustrates how much is owed by different sectors of the economy (excluding the debt of financial corporations). The data, sourced from Eurostat, includes all loans and fixedincome securities of households, corporations, and government. It is clear from this data that all sectors of the Irish economy have significant debt levels as a percentage of GDP in particular, the Government and Business sectors. High levels of existing indebtedness impact negatively on current demand for credit. Reflecting high debt levels and weak Figure 3: Composition of debt including Business Debt (% GDP), 2012 Source: Eurostat 10 National Competitiveness Council, Costs of Doing Business in Ireland, Forfás, 2014. 11 European Central Bank, Survey on the Access to Finance of Small and Medium-Sized Enterprises in the Euro Area April 2013 September 2013, November 2013. 11
growth in recent years, Ireland has the second highest Non-Performing Loan (NPL) ratio in the OECD which is undoubtedly hindering the return of banks to health raising the cost of market funding and draining resources that could be used for new lending. According to the IMF, 41 per cent of non-performing loans in Ireland relate to commercial real estate loans, 34 per cent to mortgages and 19 per cent to business and SME loans 12. The Department of Finance RedC SME Credit Demand survey is the most comprehensive study of SME credit demand. Results below relate to the period October 2012 to March 2013. Credit demand from the SME sector remains low with 40% of SMEs having requested at least one type of bank finance in the period October 2012 to March 2013. Demand has increased slightly from 38% a year ago. An improvement is registered in the perception of businesses on whether banks are lending to the SME sector. 47% of respondents now believe that the banks are lending to SMEs this is up from 39% in September 2012. Excluding pending applications (which is a large category), 76% of credit application requests were granted. The overall decline rate is 19%, compared to the 23% decline rate recorded a year ago. An increasing proportion of applications are being approved fully, rather than partially approved The survey also tracks business people s response to credit rejections: o 77% of SMEs managers who were refused credit did not agree with the reason provided by the bank for the refusal. o 21% of SMEs managers who were refused credit claim that the bank did not provide them with a reason. 6% of SMEs managers surveyed did not apply for credit because they believe the banks are not lending. Awareness of Credit Support: 73% of SMEs managers were aware of the existence of the Credit Review Office. With respect to the Credit Review Office, which deals with appeals from businesses who have not been successful in getting loans from the banks, John Trethowan observes three key trends in his latest quarterly report 13 : Reflecting a recovering economy; the majority of the appeal requests to the CRO for credit are now for working capital increases and for business investment; Demand is also being driven for refinancing debts held by foreign banks which are exiting the Irish SME lending market; The SME/Farm market is becoming increasingly concentrated with the withdrawal of foreign banks. The Credit Review Office has highlighted that this is creating a situation whereby remaining banks can achieve their lending objectives on lower risk lending, which may not be meeting the full needs of the economy. Conclusion on Balance of Demand and Supply Research from the ESRI 14 highlights that credit constraints affect a small but important minority of SMEs (between 4 and 11 percent). Mirroring the finding presented earlier, they noted that 12 IMF, Ireland Twelfth Review under the Extended Arrangement and Proposal for Post-Programme Monitoring, Country Report No. 13/366, December 2013. 13 13th report of the Credit Review Office, March 2014. 14 SME Credit Constraints and Macroeconomic Effects, Petra Gerlach-Kristen, Brian O'Connell and Conor O'Toole, ESRI, April 2013. 12
most SMEs do not apply for funding because they do not need it and that those facing credit constraints are mainly young, small firms and firms that have a domestic customer base and a debt overhang. Further, SMEs main response to the constraints is to reduce investment and numbers employed. In addition, the ESRI question the extent to which the financial system can provide adequate funding for firms once aggregate demand recovers (i.e. the economy recovers and firms seek funding) 3.3 Non-Banking Funding Sources Bank finance, while important is just one source of finance. Since 2008, we have seen strong growth in the use of share and other equity and the use of other accounts receivable. Other important sources of non-bank funding include: Figure 4: Non-Financial Corporations Sources of Funding, Q1 2002 - Q3 2013 (E m.) Equity finance, which comprises business angels and private investors, venture capital, private equity and government equity. Both CSO and Central Bank data show an increasing percentage of enterprises seeking equity investment and an increased reliance on equity investment. A specific cohort of young innovative fast growing start-ups do not neatly fit into the traditional model of bank lending and therefore rely heavily on equity finance. In addition, there is a range of more mature companies, where relatively high debt levels, suggests greater potential may exist to utilise equity to support further growth. Notwithstanding the opportunities, given the returns required to attract external equity investors and the unwillingness of many business owners to cede some business control, the potential to attract equity is only feasible for a minority of firms. Forfás published A Review of the Equity Investment Landscape in Ireland in January 2013. A number of actions have been progressed and this is an area that is being examined further by the SME State Bodies Group equity finance subgroup. Accounts receivable/ payable. As highlighted by others (e.g. the Credit Review Office), the growth in accounts receivable/ payable is of concern as it can entail businesses relying excessively on their suppliers to help finance their businesses. Late payments and the risk entailed in extending trade credit for long periods are frequently highlighted by small businesses and their representative groups. The Department of Jobs, Enterprise and 13
Innovation are supporting the development a Code of Conduct on Prompt Payments for Business and are progressing a national information campaign to raise aware of Late Payment Directive. Loans from family, friends or others. Enterprises also rely heavily, of course, on owners own resources and finance from friends and family in the early years and on retained profits as the business gets older. It is notable that limited use is made of the Seed Capital Scheme which refunds income taxes paid in the past when an individual starts a new business. The scheme is currently being reviewed by the Department of Finance. Given the difficult trading environment of recent years, many businesses have eaten into their reserves. Off-balance sheet financing sources such as lease financing, hire purchase and factoring can also play a role. Government financial support. A number of State Agencies provide funding and other supports to businesses, particularly small businesses including the Local Enterprise Boards, Enterprise Ireland, Bord Iascaigh Mhara, Fáilte Ireland and Údarás na Gaeltachta. A number of additional supports were developed to help business through the economic crisis. There are over 2bn of State supports available in the SME and farming sector, including large supports from Enterprise Ireland and the National Pensions Reserve Fund. The State supports in figure 5 were highlighted in the recent Medium Term Economic Strategy. Figure 5: SELECTED SME FINANCING INSTRUMENTS Source: Medium Term Economic Strategy, Department of Finance, 2013. Enterprise Ireland co-invests in client companies growth and job-creation orientated business plans, from high potential start-ups through to mature businesses seeking to expand their activities, improve efficiency and grow export sales. They also play an important role in addressing critical gaps in the investment landscape for Irish enterprise and helping to foster the venture capital industry in Ireland. 14
For example, in 2013, Enterprise Ireland invested in 103 new High Potential Start Up companies and also provided funding to 85 early stage entrepreneurs under its Competitive Start Fund. These companies come from a wide range of sectors including financial services, ICT, digital games, pharmaceuticals and medical devices. In terms of supporting the wider finance ecosystem, Enterprise Ireland supported the: 175 million Seed and Venture Capital Scheme aimed at leveraging private sector funds to create a total of 700 million for investment 2013-2018. 20 million Innovation Fund Ireland investment with leading international Venture Capital Fund Highland Capital Partners Europe. 125m Growth Capital Ireland Fund to focus on Irish SMEs which will focus on investing in Irish SMEs, under the Government s Development Capital Scheme. These and other initiatives are being implemented in 2014. Enterprise Ireland also plays a critical role in helping Irish companies and researchers to win international funding. By the end of 2013 over 600m of non-exchequer funding has been secured for Ireland from schemes such as Europe s Framework Programme since 2007. Horizon 2020 offers significant potential for new funding in the years ahead. 15
4. Policy Initiatives to Date, Challenges and Priorities Access to Finance for SMEs 4.1 Policy Initiatives to Date Since the start of the recession in 2007, Ireland has faced three key economic challenges. Stabilising the banking system and the public finances were clearly immediate and essential requirements and have been the focus of Government action. Thirdly, competitiveness also needed to be restored. The Action Plan for Jobs, 2012, 2013 and 2014 have played a central coordinating and driving role in this regard. Focusing on the banking system and broader access to funding, a range of major steps have been taken: Over the past number of years, the banking system has undergone comprehensive change in terms of recapitalisation, deleveraging and restructuring. In addition to initiatives to support the banking sector, measures have been developed to build business banking relationships (e.g. the establishment of the Credit Review Office and the Code of Conduct for Business Lending to SMEs ), train bank staff and increase lending (e.g. lending targets). A micro-finance fund and the loan guarantee scheme have also been established. As well as providing direct financial support, Enterprise Ireland has broadened its clients access to different sources of finance by investing in new seed and venture capital funds, matching domestic business angel and international venture capital managers with investment opportunities in client companies, and through enhanced co-operation with the main banks. Additional support is provided through workshops and engagement by Enterprise Ireland on individual cases. APJ 2013 identified the clear ambition of making access to finance a central feature of Government recovery and growth plans. All of the access to finance actions outlined in the 2013 action plan have been implemented. The activities of the SME State Bodies Group (of which Forfás is a member) and the participating Departments and Agencies have worked to achieve this goal. During 2013, a number of initiatives were rolled out in key areas such as: o Extending the remit of the Credit Review Office. The decision to increase the threshold by which SMEs can appeal refusals to the Credit Review Office from 500,000 to 3 million in Budget 2014 facilitates requests from a broader range of SMEs. It was also agreed that CRO resources would be increased. o Issuing the first call for proposals under the Seed and Venture Capital Scheme (SVC) 2013 2018. In May 2013, Enterprise Ireland launched the first call for expressions of interest under the new 175 million scheme which is aimed at providing additional funding for venture capital funds to invest in high growth firms with the potential to generate large amounts of additional export sales and grow jobs in fast growing sectors, such as the ICT and Life Sciences sectors. This first call saw 99.5 million committed by Enterprise Ireland. Further expressions of interest will be issued over the next 2 years and in 2014 Enterprise Ireland will initiate a consultative process to assist in its evaluation of what further sectors should be assisted with the remaining funds. o State involvement in new Development Capital Funds for Irish SMEs. Enterprise Ireland is progressing the Development Capital Scheme. Enterprise Ireland also continues to jointly work with the NPRF to implement the Innovation Fund Ireland strategy. 16
o NPRF SME Funds. In 2013, the National Pensions Reserve Fund (NPRF) launched a suite of three new long term funds totalling 850m which will provide equity, credit and restructuring / recovery investment for Irish SMEs and mid sized corporates. o An examination of how companies can be supported to scale by way of IPO which resulted in the Budget decision to remove the stamp duties charge on shares listed on the Enterprise Securities Market (ESM); and, o The Government has introduced a range of schemes to support the provision of funding to SME. The Credit Guarantee Scheme was introduced in October 2012 to facilitate the provision of additional bank lending to eligible SMEs by providing a 75 per cent State guarantee to banks against losses on qualifying loans. Take up of the Scheme by SMEs has not been as high as anticipated, and consequently the Minister for Jobs, Enterprise and Innovation commissioned an independent review of the Scheme, which was submitted to the Minister in Q3 2013. In 2014, a revised Credit Guarantee Scheme will be delivered with a view to enhancing the up take of the Scheme. Microfinance Ireland was established in October 2012 to provide loans from the Microenterprise Loan Fund of up to 25,000 to micro-enterprises that have been refused bank credit. The operation of this scheme will be reviewed in 2014. o The transposition of the Late Payments Directive. This focus must be maintained if we are to continue to deliver meaningful change in this vital area. The Action Plan for Jobs 2014 is building on the vision set out in APJ 2013 of an Irish economy in which all viable businesses will have an opportunity to access sufficient finance to meet their enterprise needs in a manner which supports growth and jobs. This vision is further reflected in the Medium Term Economic Strategy which states the ambition of developing a more diversified, competitive and responsive financial infrastructure that can finance SME growth. Through the SME State Bodies Group, which reports to the Cabinet Committee on Mortgage Arrears and Credit Availability, a strong focus is being maintained on implementation, policy innovation, monitoring and learning, and active engagement with a diverse range of public and private actors. Wider stakeholders also input on a regular basis. Delivering on this ambition will continue to involve all the relevant stakeholders in developing a competitive and diversified financing environment that meets the needs of an Irish economy built upon a vibrant domestic SME sector, a strong export sector, enterprise growth and innovation. 17
4.2 Plan for 2014 Access to Finance for SMEs The IMF in their latest review of the Irish economy (May 2014) note that A sustained job-rich economic recovery hinges on reviving healthy lending. Investment is beginning to rebound from depressed levels, largely financed by retained earnings. In the medium term, however, a paucity of credit would impede the domestic demand revival which is critical for job creation. Hence, there is a need to continue improving the health of the banks. Expanded nonbank intermediation can also help provide finance and share risks. At a macro level, resolving high levels of nonperforming loans and managing the ECB s ongoing comprehensive assessment of the banks is important. These are areas that that are being led by the Department of Finance and the Central Bank. As noted earlier, the Action Plan for Jobs 2014 is building on the vision set out in APJ 2013 of an Irish economy in which all viable businesses will have an opportunity to access sufficient finance to meet their enterprise needs in a manner which supports growth and jobs. The full list of access to finance actions are set out in appendix 1. To further improve access to finance for micro, small and medium enterprises in Ireland, the Action Plan for Jobs focus in 2014 is to: Increase new lending to SMEs, drawing on both bank and non bank sources of funding (Actions 205 207). In this regard, detailed data from the pillar banks will be collated and examined on a monthly basis, with a particular focus on new lending. The survey of credit demand will also continue and the activities of the Credit Review Office will be expanded further, including an enhanced role in supporting the delivery of state sponsored schemes. Increase participation in Government sponsored access to finance schemes and initiatives for SMEs such as the Microenterprise Loan Fund, the Credit Guarantee Scheme, the Seed and Venture Capital Scheme, Seed Capital Scheme (SCS), Employment and Investment Incentive Scheme (EIIS), the NPRF SME Funds and the Credit Review Office (Actions 208-211); Develop new sources of finance for SMEs (Actions 212 to 220). A range of different avenues are being explored in this respect, including multilateral development and national development banks such as the European Investment Bank (EIB) and the European Investment Fund (EIF), Horizon 2020, and alternative financing sources such as peer to peer funding, supply chain financing, etc. Raise the level of awareness amongst SMEs and entrepreneurs of the full suite of developmental business supports available through a comprehensive communications strategy involving the widest possible range of stakeholders (Action 221). The State is also harnessing the full potential of the Local Enterprise Offices as the key conduit for providing advice, information and guidance to SMEs on access to finance issues including available state sponsored supports. An online tool has been developed and recently launched which helps small businesses to navigate through the range of Government supports available to them. Upon answering a short number of questions an Irish business can access a list of potential supports for their company and relevant contact information. The guide is available on the new Local Enterprise Office website (https://www.localenterprise.ie/). Enhance the financial capability of SMEs (Actions 222-223). In Budget 2014, the Minister for Finance announced the introduction of a course, facilitated by Skillnets, designed to help business owners and managers to improve their capabilities in relation to presenting their business case when seeking to raise finance for their firm. The programme consists of 2 days dedicated offsite training together with expert mentoring support. The programme is open to owners and senior managers of small and medium sized businesses from all sectors, including farming, who want to better understand the finances of their businesses and how to better present that information to possible funders. 18
Enhance research and policy evaluation on access to finance for SMEs and the potential for innovative sources of finance (Action 224). As set out in appendix 1, a wide range of actions are underway to achieve these objectives. Progress against delivery is published quarterly under the Actions Plan for Jobs update reports. 4.3 Outstanding Challenges Much has changed in recent years and a wide range of actions are underway to ensure that viable businesses can access funding on acceptable terms and costs. Given the depth of the financial crisis and its legacy impacts on the enterprise sector, the banks and the broader economy, it can be expected that it will take some time before debt levels and funding flows return to normal levels. As noted earlier, it should also be remembered that even during the good times, small innovative export orientated businesses had difficulty accessing appropriate funding. From Forfás s perspective, some of the key challenges facing us include: There is a continuing need to ensure that the efficacy of measures put in place to improve credit flows through recapitalisation, deleveraging and restructuring of the banks can be assessed and further action taken if required. In this regard, there is a need to continue to monitor bank lending carefully. This is particularly important as the economy returns to growth and demand for funding increases. The State needs to continue to work to ensure that the banking system is aligned with the strategic economic growth targets of the economy. In this regard, a move towards a banking system with a deeper understanding of innovative sectors (e.g. software, telecoms, digital content, medtech and life-sciences) and a pro-active overseas banking network are required in the medium term. More immediately, there needs to be a focus on supporting internationally trading businesses in terms of both the provision of credit and the bank facilities/products (e.g., international invoice discounting, performance bonds and specialised leasing, etc.). The scaling back of the domestic bank sector and the withdrawal of many foreign banks highlights issues over the levels of competition in the banking sector as the business banking market has become highly concentrated 15. A particular challenge exists for those SMEs who currently rely on banks who are withdrawing from Ireland. The Programme for Government proposes to establish a Strategic Investment Bank and its place in the banking landscape and its precise role is under consideration. It will be important that this and other mechanisms put in place address the challenges set out above. Encouraging equity investment represents a mechanism to help some over-indebted but viable businesses to rebalance their balance sheets. Equity begins from the earliest stage of the business life-cycle with friends, family and founders investing at the pre-seed stage to business angels and venture capitalists investing in the seed and start-up phase right up to the latter stages through mechanisms such as trade sales and initial public offerings. Actions are required to support firms to take on equity investments, encourage potential investors to invest and support the development of equity networks/ markets. Given that a Department of Finance review is underway, now is a particularly opportune time to redesign 15 ESRI research has also found when testing the effect of bank market competition on access to finance, we find that as market power increases, and the degree of competition falls, SMEs face higher financing constraints. ESRI Research Bulletin, Does Bank Market Power Affect SME Financing Constraints? Conor M. O'Toole (ESRI), Robert Ryan (TCD), Fergal McCann (Central Bank of Ireland), March 2014. 19
the EIIS/ SCS to ensure that they deliver on their potential to support the funding needs of growing businesses. The State can also support other forms of funding. The Committee recently heard from peer-to-peer lenders and businesses that they have supported. There is strong potential for the State to provide a supporting environment to alternative sources of finance such as these. 20
Appendix 1: Action Plan for Jobs 2014 Access to Finance for SMEs The following actions are aimed at improving the access to finance environment. Increase New Lending from Banks to SMEs 205 Detailed data from the pillar banks will be collated and examined, on a monthly basis ensuring a more informed understanding of the SME bank lending environment, with a particular focus on new lending. (D/Finance, Credit Review Office) 206 Survey the demand for SME credit. (D/Finance) 207 Expand the activities and reach of the Credit Review Office in supporting SMEs to access finance, including an enhanced role in supporting the delivery of state sponsored schemes. (Credit Review Office, D/Finance, DJEI) Increase Participation in Government Sponsored Access to Finance Initiatives for SMEs 208 Enhance the take-up and impact of the Credit Guarantee Scheme on foot of the 2013 review of the Scheme by implementing the appropriate recommendations. (DJEI, Credit Review Office, EI, D/Finance) 209 Improve the take-up and impact of the Microenterprise Loan Fund through closer engagement with the SME lending banks and business representatives and implementing appropriate recommendations from the review of the scheme. (DJEI, MFI, Credit Review Office, D/Finance, SME Lending Banks) 210 Enterprise Ireland will issue a consultation exercise to inform the sectoral and development stage focus of future calls for expressions of interest under the Seed and Venture Capital Scheme 2013-2018. (Enterprise Ireland) 211 Monitor and review the progress of the NPRF SME Funds in providing finance to SMEs. Furthermore in the context of the ISIF s investment strategy additional commercial opportunities within the SME sector will continue to be developed as appropriate. Develop New Sources of Finance for SMEs 212 Work with KfW and the German Ministry of Finance to develop an initiative that will improve funding mechanisms for SMEs. (NPRF) (D/Finance, NPRF) 213 Increase our engagement with the EIB and EIF in developing and implementing mechanisms designed to maximise the provision of financing to SMEs. (D/Finance, DJEI, EI) 214 Develop an initiative that will provide a suite of working capital products for 21
exporters. (D/Finance, DJEI, EI, NPRF) 215 Continue to engage at EU level to ensure that the European Long Term Investment Funds are designed in law so that they can have the greatest potential benefit in terms of channelling productive investment to Irish enterprises. (D/Finance) 216 Implement the Government s strategy for the EU s Horizon 2020 programme in a manner that maximises the potential of the Access to Risk Finance element of this EU Programme, as a vehicle for providing finance to SMEs. (EI, DJEI, D/Finance) 217 Develop proposals to support the development of alternatives to bank financing within Ireland. (D/Finance, DJEI, EI, NPRF) 218 Explore the feasibility of developing a framework for a private placement market for Ireland. (D/Finance) 219 Work with the Irish Stock Exchange to establish a retail mini bonds market for Ireland. (D/Finance, DJEI, EI, NPRF) 220 Advance solutions to improve cash-flow to SMEs, using appropriate supply-chain finance initiatives. (D/Finance, NPRF, SME State Bodies Group) Raise the Level of Awareness amongst SMEs and Entrepreneurs on the Full Suite of Government Supports 221 Implement the Communications Strategy developed by the SME State Bodies Group. Enhance the Financial Capacity of SMEs (D/Finance, DJEI, D/Taoiseach, EI) 222 Deliver the Building Financial Capability in SMEs programme by Skillnets and undertake an evaluation of this initiative. (DES, DJEI, D/Finance) 223 Develop a financial capability programme for micro and small businesses through the LEOs network. Enhance Research on SME Access to Finance (DJEI, LEOs, IBF, EI, Accountancy Bodies) 224 Oversee a focused research programme on SME access to finance issues that will inform the on-going deliberations and policy actions of the Group during 2014. (D/Finance, DJEI/Forfás, EI, NPRF, SME State Bodies Group) 22