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Apr 29, 2013 | 11:57 GMT

6 mins read

In the Eurozone, Smaller Businesses Struggle for Financing

In the Eurozone, Smaller Businesses Struggle for Financing

On April 26, the European Central Bank released a report analyzing the financial situations of small and medium sized enterprises in the eurozone between October 2012 and March 2013. The report shows that access to financing differs greatly among the eurozone members, especially between the struggling peripheral economies and Germany, and that securing bank lending generally is harder for small companies than large ones. Small and medium sized enterprises are, as widely acknowledged, the backbone of the European economy. Using employment and value added as measurements, this is especially true in the struggling peripheral eurozone countries. European economies rely heavily on banks as a source of credit, compounding the crisis in countries with troubled banking sectors.

The European Central Bank's monetary policies are not sufficiently improving access to financing for small companies in struggling countries and thus the bank is likely considering alternative measures to fine-tune its policy to better serve smaller companies. However, the central bank is constrained by the eurozone's structure. Moreover, monetary policy can do little to correct structural faults such as weak international competitiveness and low domestic demand.

The European Union's statistical office, Eurostat, generally defines small and medium sized companies as firms with fewer than 250 employees (micro companies employ fewer than 10 people, small companies employ between 10 and 49 people, and medium sized companies have between 50 and 249 employees). In its last annual report on small and medium sized enterprises, issued in September 2012, the European Union stated that the bloc's small and medium sized enterprises account for two-thirds of all jobs in the private sector and create 58 percent of the value added. The European Central Bank has reported that in the eurozone, small and medium sized businesses account for three-fourths of employment and generate 60 percent of value added. In contrast, the U.S. Small Business Advocacy Office has reported that small and medium sized businesses in the United States (generally firms with fewer than 500 employees) account for 50 percent of private sector employment and 46 percent of private sector output.

Small Businesses in the Eurozone's Periphery

Germany's small and medium sized companies are often presented as the prime example of the strength of such businesses and their importance to economies in Europe. However, EU data shows that smaller companies are even more important in the eurozone's currently struggling peripheral economies. The difference can be explained by the importance of certain sectors (such as construction) in the economy or by national preferences for self-employment and family companies. Based on country reports from the European Union for 2012, small and medium sized enterprises in eurozone crisis countries like Spain, Greece and Portugal are more important than the EU average in terms of employment as well as value added to the national economy.

Chart - Eurozone Small Businesses

According to EU data, between 2002 and 2010 small and medium sized businesses created more than 85 percent of the net new jobs in the European Union. However, since the onset of the European financial crisis, these businesses have lost jobs faster than large companies since they lack the capital to retain workers when there is no business. Therefore, the difficulties that small companies face in securing financing deepen the European unemployment crisis.

Low domestic demand and the continued emigration of well-educated people worsen conditions for smaller enterprises in the periphery. Germany and Austria have been more resilient to the crisis, in part because high-tech and knowledge-intensive small and medium sized businesses — which are considered very productive and add the most value and jobs among all smaller enterprises — are more numerous there than in crisis countries such as Spain, Portugal and Greece. Moreover, smaller businesses are considered less internationalized than larger companies, trading mainly domestically and within the European Union. This makes recovery difficult as the European consumer market weakens. Finding customers is the main concern for smaller economies in the eurozone and is becoming more of an issue for trade-oriented countries such as Germany and the Netherlands.

Difficult Access to Finance

In Europe, companies are more reliant on banks as sources of financing than in the United States. Smaller businesses are particularly affected by a banking crisis because they rely more heavily on bank lending to finance themselves than large companies that can use other financial instruments such as bonds and stocks.

The European Central Bank's "Survey on the Access to Finance of Small and Medium Sized Enterprises in the Euro Area" shows that only in Germany did smaller companies see the availability of bank loans improve. Generally, the availability of bank loans is still deteriorating, although the situation is less dire than during the previous survey covering April through September 2012. Fewer small and medium sized businesses are rejected when asking for a loan (11 percent, down from 15 percent), and fewer see access to finance as their main problem (16 percent, down from 18 percent). However, smaller companies' need for bank loans is still rising, especially in Greece, Italy and Portugal, and lending conditions diverge greatly within the eurozone. For example, in Greece 38 percent of respondents (and 24 percent of respondents in Spain) said access to finance was their main problem, compared to 8 percent of respondents in Germany. Small and medium sized enterprises in Spain, Italy and Portugal reported particularly strong increases in bank lending rates in contrast to companies in Germany, France and Austria.

These developments cause concern for the European Central Bank. Since the outbreak of the crisis, the bank has taken unprecedented measures to prevent the collapse of the banking system and uncontrolled sovereign bankruptcies in the eurozone by lowering interest rates and providing more than 1 trillion euros in long term loans in late 2011 and early 2012, as well as promising to keep the eurozone from collapsing. However, despite the well-developed financial system in the eurozone, the European Central Bank is having problems reaching small and medium sized enterprises, particularly in crisis countries, through commercial banks. In several countries, banking sectors either are undergoing major reforms and restricting lending or have used the European Central Bank credit mainly to buy government debt, decreasing borrowing costs for troubled states but changing little for smaller companies. Moreover, weak demand as a result of increasing unemployment makes it especially risky for banks to lend to small enterprises.

On April 24, the Bank of England announced measures aimed at increasing the incentives for banks to lend to small and medium sized companies in the United Kingdom. Also, the European Central Bank reportedly is considering new measures to improve the credit situation for smaller businesses. A number of options are under consideration, such as further lowering the collateral requirements to give commercial banks greater incentive to lend to small companies. However, in the eurozone such stimulus is controversial since the bank only has the mandate to control inflation. While the European Central Bank has to implement monetary policy for 17 different countries with vast differences in economic performance and structure, it has little power to ensure that the lending it provides stays in the area that is struggling most, since capital flows freely throughout the eurozone (apart from Cyprus). The bank likely will take further measures in an attempt to reduce the fragmentation among small and medium sized businesses in the eurozone.

However, although the bank's actions have prevented the collapse of the European banking system and sovereign defaults in Spain and Italy, the European Central Bank's ability to improve the business situation for smaller companies in struggling countries is limited. The situation in the financial markets and the real economy are not directly connected, especially in crisis countries. While borrowing costs for governments have dropped recently, austerity measures and low consumer confidence still harm small businesses. The European Central Bank's actions have a relative instantaneous effect on lending conditions for banks and sovereign interest rates, but reviving demand is more difficult and takes far longer. Therefore, the bank has little power to end Europe's deepening unemployment crisis and growing social discontent.

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