The EU’s Failed SME Bank Lending Initiative

The European Union is in the midst of several upgrades and overhauls within its financial sector, including ongoing efforts to improve access to working capital for the region’s small and medium-sized businesses.

Post-financial crisis, amid economic recovery, financial institutions across the EU have been calling for a cut in capital charges if they are to ramp up their lending, especially to SMEs.

According to reports, banks have been tasked with holding more cash to support the loans they provide following the financial crisis. Heeding FIs’ calls, however, EU officials launched the SME Supporting Factor (SME SF), a policy that allows banks to hold less capital against their loans provided to small businesses.

Last week, the European Banking Authority (EBA) released a report to examine whether the SME SF, initiated in January, has proven successful in giving banks an incentive to provide financing to SMEs.

Apparently, it hasn’t.

According to EBA, “there is no evidence that the SME SF has provided additional stimulus for lending to SMEs compared to large corporates,” the report concluded.

The latest figures show levels of bank lending to large corporates has recovered back to pre-crisis levels. SMEs, on the other hand, have not seen the same revival. EBA also pointed to recent research that found small businesses report a higher prevalence of negative experiences when seeking financing from a bank — including instances of being discouraged to apply, being met with too-high costs and getting outright rejected for a loan — compared with their larger counterparts.

Reports published following the release of EBA’s findings suggested that the conclusions could be bad news for the region’s financial institutions and could support lawmakers’ argument that banks are more apt to finance businesses when they have more capital on the books.

But EBA also noted that its report is not an exhaustive one, with researchers relying on a limited sample of SME loans across just three EU Member States.

“Consequently,” the report stated, “a more complete conclusion of a systematic overestimation across all EU Member States for all SME exposures may not be inferred, and thus neither does the study fully justify nor fully reject the SME SF for this purpose.”

Still, the authority did use its findings to set forth several recommendations for the EU as it moves forward in efforts to improve SMEs’ access to bank financing.

First, EBA declared, continual monitoring of the SME SF and its impact on the market will be key.

This includes heightened collection of data, not only on SME lending but on the effects of capital requirements on risk exposure to FIs.

Second, EBA stated that a “more comprehensive” assessment must be taken to adjust the approach to improving SMEs’ access to bank capital. The body found in its review that the impact of the SME SF has led to varying degrees of impact depending on the loan portfolio — suggesting that risk weights should be more thoroughly taken into account, instead of introducing a fixed discount across banks and across loan portfolios.

Third, EBA recommends that regulators address the amount owed limit criterion under the SME SF; finally, EBA suggests that authorities agree upon a consistent definition of “SME” when applying the Supporting Factor.

“The harmonization of the SME definition would lead to better implementation and consistency in the regulation and comparable data on SMEs and hence could be used for the monitoring of SME lending, riskiness and the impact of the application of the SME Supporting Factor,” the report concluded. “This would also allow building a more comprehensive data set on SME riskiness.”

An array of factors can impact the definition of an SME depending on market, EBA said, including the size and strength of the national economy, the size of the lender or a bank’s business model.

Having only been implemented in Jan. 2014, the SME SF is at a too-early stage to address the impact on SME lending, the European Banking Authority noted. Plus, its own analysis was far from expansive.

Still, without evidence thus far that the SME SF has actually done its intended job — increase bank lending to SMEs — EBA argued that the legislation must be watched closely and adjusted accordingly to get SMEs back to their pre-financial crisis levels of access to capital.