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IMF Survey : Europe Needs to Revitalize Finance for Small and Medium Enterprises
November 5, 2014
- Small-and-medium enterprises in Europe face difficulties in obtaining bank loans
- Diversifying funding sources can enhance job and growth prospects
- Bundling high-quality loans and developing markets for distressed assets should help ease financing
Increasing access to finance for small-and-medium (SME) enterprises is vital for Europe to support a firm recovery and enhance the growth and employment outlook, according to a recent seminar on SME financing.
Seminar participants considered two areas for unlocking SME financing in Europe: securitization and developing a market for nonperforming loans (IMF photo)
SEMINAR ON SME FINANCING
As the euro area recovers slowly from the financial crisis, banks remain weighed down by bad loans and need to raise additional capital. In many countries, small- and- medium enterprises—which account for the bulk of employment in Europe—face difficulty in getting credit.
This was the theme of a high-level seminar on “Unlocking SME Financing in Europe and the Role of Capital Markets,” held in Brussels during October 22-23 and co-hosted by the International Monetary Fund (IMF) and the European Investment Bank (EIB).
“The economy of the euro area is like an airplane flying on one engine—bank lending. Developing a second engine—capital markets—would help diversify funding for small-and-medium enterprises and provide more long-term financing,” said Yves Mersch, a Board Member of the European Central Bank (ECB), in a keynote speech.
Over 80 seminar attendees—policymakers and market participants—considered proposals to revitalize credit to SMEs. The EIB’s Economics Department Director, Debora Revoltella, chaired a panel discussion on developing markets for distressed bank assets, to help banks dispose of bad loans and start lending to businesses again. The IMF’s European Department Deputy Director Mahmood Pradhan, chaired a separate panel session on bundling together high quality SME loans—a process called securitization—for sale to a broad base of investors.
More funding options
European firms, in particular SMEs, depend heavily on bank financing. This reliance is clearly evident in the wake of the financial crisis, as banks face capital constraints and a severe deterioration in the quality of the assets on their balance sheets. This, in turn, has made many banks reluctant to lend to relatively high-risk sectors such as SMEs.
Seminar participants agreed that the ECB’s comprehensive assessment of banks’ asset quality review and stress tests is a vital first step. However, they also stressed the need for concerted efforts to ensure that sluggish bank lending does not exert a drag on the already fragile economic recovery in the euro area.
Seminar participants analyzed the role that capital market development could play in unlocking SME financing in Europe. In this regard, two channels of development seemed promising: securitization and developing a market for nonperforming (bad) loans.
Bundling high-quality loans
Panelists argued that securitization could help mobilize non-bank financing sources for SMEs. Unlike the “toxic” securities—typically complex and opaque structures—that contributed to the global financial crisis of 2008, most European securitization transactions are relatively simple and transparent, and have proven resilient to unfavorable economic conditions. But the market for SME securitization is currently small, with the investor base largely restricted to banks issuing securities for collateral purposes.
“Securitization can be seen as an instrument to reshape the funding of the European economy whereby long-term investors such as insurance companies and pension funds are given a more important role in funding the economy while preserving client-banks relationships,” said Costa da Silva, Governor of the Bank of Portugal.
Andy Jobst, IMF Senior Economist, argued that a multi-pronged policy approach is needed to revitalize SME securitization. These would comprise: more lenient regulatory treatment for transparent, high quality securitization (HQS); a mutual issuance platform for European firms; and time-bound public sector support to kick-start the market. Participants noted that the strategies were complementary, and would work best in tandem.
Developing markets for bad loans
The seminar also focused on how to reduce the burden of non-performing loans on banks’ balance sheets, so that they can start lending to businesses again. Market participants pointed out that there is currently a gap between the price that potential buyers are willing to offer and the price that sellers are willing to accept. To some extent this can be addressed by tougher regulation by the new pan-European bank supervisor; forcing banks to make greater provisions for bad loans would increase their incentive to sell them. Other impediments include the cost of enforcing legal contracts, the lack of standardization of corporate loans (unlike, say, residential mortgages), and the difficulty of coordinating multiple creditors.
Ken Kang, Assistant Director in the IMF’s European Department, drew lessons from Korea after its banking crisis. He noted that developing a market for distressed assets can support banks’ efforts to reduce NPLs, address the private debt overhang, and promote needed corporate restructuring. According to Kang, “so-called corporate restructuring vehicles (CRVs) are a way to leverage outside financing and expertise to help banks dispose of problem loans and close the pricing gap.”