SME - access to finance Flashcards
Sources for UK small and medium enterprises?
COVID loans, big banks (main in recent years), challenger banks, P2P lending, crowdfunding
SME finance monitor?
New barrier impact of pandemic remained top in Q4 2020 -
others included current economic climate, political uncertainty/future govt. policy, legislation etc.
Main types of business finance?
- Internal – profits and savings
- External – family and friends, bank loans, bonds, securities, equity, state funding and subsidies
Access to finance key issues for SMEs?
- 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?
Pecking order theory?
- 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
Pecking order theory - implications?
- Debt and internal funding most widespread type of finance
- Equities and bonds not likely to be important
- 3, Risky firms borrow less
- Banks assumed more willing to lend to large firms since asymmetric info more important for SMEs
Relationship banking as solution to SME problems?
- 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
Decentralised v centralised financial system?
- 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
Geography matters?
- 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
Conclusions?
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
