SME - access to finance

Question 1

Sources for UK small and medium enterprises?

Answer 1

COVID loans, big banks (main in recent years), challenger banks, P2P lending, crowdfunding

Question 2

SME finance monitor?

Answer 2

New barrier impact of pandemic remained top in Q4 2020 -

others included current economic climate, political uncertainty/future govt. policy, legislation etc.

Question 3

Main types of business finance?

Answer 3

• Internal – profits and savings
• External – family and friends, bank loans, bonds, securities, equity, state funding and subsidies

Question 4

Access to finance key issues for SMEs?

Answer 4

• But for lenders – role of information/adverse selection and moral hazard
• Loan application – bank carefully scrutinise SME performance
• SME -> more diff access to information
• External finance might be more expensive for SME?

Question 5

Pecking order theory?

Answer 5

• Myers and Majluf 1984
• SME owner prefers to cover financing needs, firstly by internal funds to avoid transaction costs
• When high profits, the firms will pay off debt or invest in marketable securities
• If no profits, the firms is financed externally -> most SMEs : low profit yields
• So most SME resort to external finance
• SME will be externally finance firstly by debt, then other securities like convertible bonds and finally new issues of equity
• Commercial banking constituted the dominant external source, but with SMEs typically having to pay more
• Resistance to equity path from small firms linked to concerns over loss of ownership

Question 6

Pecking order theory - implications?

Answer 6

• 1. Debt and internal funding most widespread type of finance
• 2. Equities and bonds not likely to be important
• 3, Risky firms borrow less
• 4. Banks assumed more willing to lend to large firms since asymmetric info more important for SMEs

Question 7

Relationship banking as solution to SME problems?

Answer 7

• Banks perhaps best positioned to overcome the information asymmetries associated with financing SMEs
• SME external finance is facilitated by relationship banking
• SME external finance is facilitated by personal contacts between owner/manager and the bank
• SME external finance is facilitated by geographical proximity to the bank branch
• But..
• Bank branches close to SME trading locations may facilitate the use of socially embedded soft information in SME credit analysis. Indeed, such proximity has been shown to be a prerequisite for relationship banking that better enables the credit market for SMEs, particularly in poor areas (Zhao and Jones-Evans, 2017).However, banks that have branches closer to the borrowing firms might enjoy an information-based monopoly that potentially allows them to extract excess rents from borrowers
• Recent bank closures can be a real problem for SMEs

Question 8

Decentralised v centralised financial system?

Answer 8

• Germany has a more decentralised system than the UK
• Regional financial markets are essential in mobilising funds
• A centralised financial system may lead to regional funding gaps

Question 9

Geography matters?

Answer 9

• Financial systems with small and local financial intermediaries -> greater propensity to lend to SMEs
• SMEs in peripheral regions with less advanced financial development and infrastructure are expected to have restricted access to finance
• Scope for intervention – Development Bank of Wales
• New finance sources – e.g., P2P lending and equity crowdfunding

Question 10

Conclusions?

Answer 10

 External finance is very important for SMEs
 SMEs are more credit-dependent, due to their low level of profitability and productivity
 Information, risk, and uncertainty levels matter ->Trust!
 Commercial bank lending is the primary source of external finance for SMEs
 Problems difficult access to information, high bankruptcy risk, lack of collateral
 Importance of geography in SME finance
 The pandemic is likely to imply dramatic changes