ECONOMICS: Small businesses and banks give widely differing views on credit availability

THE ECONOMIC recession has focused attention on the importance of small and medium-sized enterprises (SMEs) for growth in all countries.

SMEs are more labour-intensive than large firms and account for about two-thirds of European employment. Another distinguishing feature is their reliance on banks for finance. SMEs do not normally issue securities and, as a result, rely more heavily on bank credit than large firms.

In Ireland, the importance of bank funding for the SME sector has been recognised and the Government has taken a number of steps to encourage lending:

* Continued availability of credit to SMEs was a condition of the September 2008 bank guarantee scheme;

* Similar conditions were attached to the capital injections of €3.5 billion each to AIB and Bank of Ireland in February 2009;

* Under the bank recapitalisation programme, the Department of Finance requested that lending to SMEs be monitored. This led to the compilation of two reports by Mazars, published in June and December 2009;

* The 2010 budget announced the establishment of a credit review process, which will provide an appeals system for SMEs and periodic reviews of banks’ lending policies.

So how successful have these initiatives been? Small business representatives and banks articulate widely differing views on credit availability. The former claim that a tightening of credit standards by banks has made it virtually impossible to obtain funding. Banks, on the other hand, say that ample funds are available for viable loan applications.

The Mazars reports provide valuable information on what is going on.

First, how has SME lending evolved? The December report shows that between February and September 2009, overall lending fell by 2.6 per cent to €32.7 billion. Within this, however, the important loans category, which accounted for more than four-fifths of the total, was only 1 per cent lower. In addition, almost half of approved overdraft limits remained unutilised.

The amount of new credit drawn down was measured for the first time; this shows that more than €2.6 billion in new credit was advanced to SMEs over the period.

Second, what has been the relative importance of demand and supply factors? On the demand side, loan applications have fallen and a higher proportion of these have been working capital or cash-flow based, with more than two-thirds of firms surveyed saying these were the main reasons they required credit.

The number of formal applications to banks fell by over one-quarter between June 2008 and September 2009, while the average application size was also significantly lower. This brought the value of credit applications down by 54 per cent.

On the supply side, SMEs report an increase in decline rates – with “micro” firms having the most – while banks have recorded a drop in credit quality.

A change in bank-lending policy was the most common reason for declines indicated by SMEs but, in the December report, there was a marked increase in the extent to which firms also quoted a deterioration in business performance.

While banks reported little change in their decline rates, there was a large rise in the proportion of SME loans classified as “watchlist” or “impaired”. These rose from 15 per cent of lending (in value terms) in June 2008 to 32 per cent in September 2009 and clearly reflect the trading and cashflow difficulties referred to by SMEs.

Thirdly, we must ask, in the context of a shrinking economy and a fall in total credit, have SMEs fared better or worse than other borrowers?

The four retail clearing banks and Anglo Irish contributed to the Mazars studies. These banks’ SME loans and overdrafts fell by less than total retail clearing bank loans and overdrafts between February and September 2009. The 1 per cent decline in SME loans was much less than the 6.3 per cent fall in total loans. SME overdrafts shrank by 4.2 per cent; the total fell by 6.6 per cent.

The exclusion of the speculative construction and real estate sub-sectors from the SME figures may partly explain the loans outcome. However, sectoral data show that in key sectors like hotels and restaurants and wholesale/retail trade, SME lending was also more robust than total credit.

This does not mean that there are no supply constraints. Almost certainly, credit standards have tightened. Worsening credit quality, funding issues and the need for banks to improve their loan/deposit ratios are undoubtedly factors.

Could changes in regulation also be important? Could the new “intrusive” supervision of banks’ operations be having an over-restrictive effect on credit and offsetting the Government’s initiatives in other areas?

The on-site presence of Financial Regulator staff, and their attendance at credit committees, will not encourage banks to approve anything but the most secure loan applications.

Although banks have been less restrictive in lending to SMEs than to other borrowers, firms may still have below-optimum access to credit. Decline rates have risen and a deterioration in their trading environment is making it more difficult for firms to obtain finance. Most loan requests are to improve cash-flow and, with growth prospects uncertain, these can be difficult for banks to assess. A guarantee scheme, as recently mentioned by Tánaiste Mary Coughlan, would certainly help.

The Mazars reports are not definitive on whether credit to SMEs is adequate but the risks are skewed.

Banks may have lent too much in an era of ineffective regulation. It is important that the pendulum should not swing too far in the other direction. If SMEs cannot obtain adequate finance, the cost will be slower growth and higher unemployment.

John Kelly is a former head of statistics at the Central Bank