by Seán Whelan, Economics Corresponent
One of the chapters in the latest Global Financial Stability Report from the IMF looks at the problem of banks that can not or will not lend money. It’s not just an Irish problem.
According to the IMF (using Bank of International Settlements data) weak credit supply from banks is a problem for Austria, Belgium, Denmark, Germany, Greece, Italy, Luxembourg, Norway, Portugal, Spain, the UK and the USA – as well as Ireland.
Triple A or junk, euro or non-euro, this side of the Atlantic or the other, it doesn’t seem to matter – quite a lot of the world’s advanced economies have problems with their banking sector not lending to the private sector.
And it gets worse. The chapter (two, as you ask) says “many countries with near-zero or negative credit growth for a number of years sense that the strategy of very accommodative macroeconomic policies has been insufficient in reviving credit activity”.
So even ultra low interest rates (a 300 year low in the case of the Bank of England), LTRO’s, quantitative easing etc has not been enough to supply the motors of the economy – SMEs – with the fuel they need – credit.
In the week that Ireland’s Central Bank reports yet another month of falling credit to the household sector (down 2.3% annualised), the IMF says lots of governments have been trying a host of policies in an attempt to boost credit creation.
One element in particular caught my eye – a “box” on policies to diversify credit options for small and medium enterprises (SMEs) in Europe. As we know SMEs are the main job creators in Europe, so if they can’t access credit – and surveys suggest many of them can’t – then it’s bad for job creation, economic growth and fiscal sustainability.
The IMF points out that the ultra low interest rate environment has been beneficial for big corporations, who have been able to fund their debt very cheaply and gain access to liquidity. They have long been able to raise money by issuing bonds – now they can do so cheaper.
SMEs can’t access the bond market for money. And the low interest rate environment doesn’t always mean low interest rates are available – especially if you live in one of the high stress euro zone states.
And SMEs were hit harder by the crisis than the big boys. The IMF says there is evidence that the magnitude in the reduction of credit supply was significantly higher for firms that were smaller, younger and had weaker banking relationships (as measured by the volume of their bank credit pre-crisis).
So what can be done to help. The IMF suggests the following:
1 – Develop primary and secondary markets for securitisation for SME loans. At present the euro area securitised bond market is worth about €1 trillion, but only €140 billion of this was backed by SME loans. This compares to bank loans to SMEs of €1.5 trillion. Clearly there is scope for improvement, and securitisation is a veritable industry in Dublin’s IFSC, so there is potential for a double win here.
2 – Address the unequal treatment of securitised assets versus other assets with similar risk characteristics. Securitised assets are treated less favourably by investors and central banks. For example, the haircut the ECB applies to asset-backed securities is 16% – much more than on other assets of similar risk, such as covered bonds with a similar rating. There are also inconsistencies in capital charges that create incentives for covered bond issuance and bank cross holdings of covered bonds at the expense of securitisations.
3 – Introducing government guarantees for SME securitisations. These would effectively be credit enhancements, offsetting some of the SME credit risk, and would encourage investment from investors that can only buy securities with certain minimum credit ratings. OK we have only just gotten rid of the bank guarantee, but it may be necessary to guarantee SME loans, at least for a while, to get the securitisation process started.
4 – Include SME loans in the collateral pool for covered bonds. Currently only mortgage, municipal, ship and aircraft loans are eligible collateral for covered bond issuance – The IMF says extending eligibility to SME loans would make them more attractive.
5 – Improving information disclosure about SME securities would lead to a better risk evaluation process. This would reduce investor uncertainty about the quality of SME securities, and thus lead to lower borrowing costs.
The IMF even cite a 2010 article by Central Bank Governor Patrick Honohan in support of the idea of market based credit guarantee programmes and the development of small-bond markets. Government backed partial credit guarantees and mutual guarantee programmes could help expand credit to SMEs, it says. And it notes approvingly the introduction in Italy last year of incentives for the issuance of mini-bonds by unlisted firms.
Other ideas include tax incentives for banks that lend to SMEs (though that is full of caveats about distortions and perverse incentives), and facilitating the establishment of “direct lending” funds targeting SMEs that can’t get money anywhere else. Such lenders would include distressed-debt firms, private equity, venture capital firms, hedge funds and business development corporations.
But the IMF are not the only ones thinking about non-bank finance, particularly for small businesses. One of the initiatives of the Irish EU presidency was the establishment of a working group of senior officials to look at ways of expanding access to credit for firms.
It is chaired by John Moran, the Secretary General at the Department of Finance, and it is due to report quite soon, possibly later in October. It’s a sub-group of the Economic and Finance Committee, which prepares the work of the ECOFIN council, the meeting of EU finance ministers, so it’s a serious group.
One of the things driving it is the knowledge that in the US, around three quarters of company funding comes from non-bank sources, while in Europe it’s the other way round. This over reliance on bank financing is a real problem now, when the banks are hardly lending across the EU, and firms need credit to grow.
The growth of other sources of finance is a growing theme here. There was the launch earlier in the year of three funds, backed by the National Pension Reserve Fund, to channel money into SMEs, and even last week’s establishment here of Dell Bank, which will supply finance for firms to buy technology. And there is the daddy of them all, NAMA, which is now in the business of supplying vendor finance – in other words it sells you an asset and lends you the money to buy it with. It is also becoming a major source of finance for construction in Ireland.
So it looks like we are heading for a situation in which entities that are not banks lend money, and entities that are banks don’t lend money. Debt collectors with banking licenses – what will they think of next?
PS The Central Bank of Ireland has just published its own analysis of efforts to boost SME credit access here. More of this anon…..