Think small first... a cliché without substance

By Jaromir Sant

PKF, being itself an SME-sized firm of auditors and consultants, has pioneered to prepare a study on interest charges on SME loans.

The popular question is why access to finance SMEs is perceived as a higher risk and therefore necessitates a higher collateral. As revealed in a previous article our efforts to conduct a study on the banking sector found hurdles in obtaining the data necessary to identify loans and their average cost of borrowing for amounts under €1million.

The protection of the status quo by dominant financial institutions, vested under the name of Data Protection Act and Commercial Sensitive Data, reigns supreme when on the face of it there should not be such a fuss by the respective operators to divulge or give access to data. It is ironic that in practice one finds such stumbling blocks when the EU Commission repeatedly comes across as a guardian of SMEs and encourages member states to full transparency and reduce bureaucratic measures.

When one digs deeper into the issue, one realises that there have been a number of smaller banks which set out to take deposits from the public. Yet it is a well known fact that roughly 90% of all the banking market is taken by HSBC and BOV, and critics may well conclude that in reality this is a quasi-duopoly.

But is this considered a healthy market with multiple sources for access to finance?

Perhaps not, but then the argument goes that the market is too small to sustain multiple banks. Otherwise the cost of credit will be higher and there will be an over-supply of loan opportunities to a restricted pool of applicants.

All this is rebutted when one reads the exhortations by the Commission to member states to improving access to finance, especially to SME’s. Economic theory tells us that the ideal market structure for consumers would be perfect competition, an environment in which there are an unlimited number of producers facing no barriers to entry with perfectly elastic demand curves.

In this case however, the market structure is continuously evolving. There are a number of new albeit smaller players in the market, although the perception is that being new to the market there is a tendency for established customers to prefer the older and bigger banks. This level of risk aversion may decrease as the new banks offer better terms and gradually penetrate deeper into the domestic market.

It is against this background that one comes to understand how difficult SMEs find access to finance. Being smaller companies with a smaller share of business than other large, multinational corporations, these enterprises are seen as being risky applicants for a loan. What this translates into is higher interest rates on loans, adding to the already high charges. How can one expect a small business, in many cases one which is still starting up and will definitely be registering losses in the first few periods of its operations, to afford to pay such high interest rates?

One only has to check data from EUROSTAT to confirm that such high interest rates are indeed being charged. By considering interest rates for the outstanding amount on loans with maturity over one year, over one year and less than five years, and over five years, it becomes obvious that Maltese consumers, primarily businesses, face higher interest charges than other euro area counterparts.

In some cases, the interest charged was as high as one and a half times that of the euro area average (in December 2010 interest charged for the outstanding amount on loans with maturity dating between one and five years was on average 5.45% in Malta and only 3.42% in the euro area).

But problems to access finance  are not endemic to Malta. An ECB survey regarding the access to finance of enterprises (SAFE) is held every half-year, whereby SMEs from the euro area are asked a number of questions on this topic. The most recent issue, published on April 30, 2014, included the response from 7,520 firms, of which 6,969 employed fewer than 250 employees.

The results indicated how access to finance is a top concern for SMEs in the euro area. Not surprisingly, SMEs interviewed reported a decline in bank loan availabilities, a decrease of 4%, together with a slight improvement in rejection rates, going down to 11% from the previous 12%. However the survey underlines yet again the large discrepancies observed between one country and another as well as the inherent difficulty SMEs face in accessing finance when compared to larger companies.

With the current economic climate featuring weak and low inflation rates and high interest rates on loans, how can one expect the local economy with its current drop in exports to fire on all cylinders? The trend of low inflation rates has to be properly monitored to avoid any possibility of falling into a damaging deflation.

On the other hand, this can only be done by nurturing the economy, something which is being effectively hindered if businesses are faced with risk-averse banks and higher cost of borrowing. It is true that it was partly due to the prudence of banks that Malta did not suffer any humiliating bail-out conditions imposed by the Troica as happened in a number of other larger countries.

Banks in Malta did not venture into high risk investments to double their return on capital and therefore when the crunch hit our shores the banks were found to be safe and could withstand the turmoil. Still, prudence did not mean that banks slowed down their fervour in their Midas touch and in fact they reported double digit growth even in years when the local economy was in recession or had just started to recover.

The pendulum cannot swing widely out of control and some argue that the exemplary profits by the financial institutions were reflected in higher overheads paid by the exporting and manufacturing sectors.

Here enters Malta Enterprise – a watchdog with noble aims including the “growth and development of Maltese enterprises both locally and beyond our shores”.

As is very well known, Malta Enterprise offers a wide variety of aid programmes for various SMEs, from start-ups to established small enterprises. This is all well and good, and readers are more than impressed when browsing its website and seeing the vast schemes on offer, tailor-made according to business size, focusing on the market the business intends to target and so on and so forth.

However not all is as rosy as it seems. The age-old disease which is commonly known as bureaucracy strikes yet again. If one consults the ratings given to Malta with regard to Competitiveness ratings (issued by the World Economic Forum), it is precisely the number of procedures needed to start a business and the number of days required to start a business which find Malta lagging behind.

Out of 148 countries, Malta is ranked 126th and 124th in these two categories respectively. Why should it take a business in Malta 40 days to start when it takes only six days in the US, five days in Canada and four days in Belgium? Why does it take 11 procedures to start a business here in Malta when it takes six in the US, three in Belgium and only one in Canada?

Surely we can’t hope that these burdens on Maltese companies are anything but deterrents to business. Such facts are even more worrying when one realises how highly ranked the intensity of local competition is in Malta. We are ranked 4th in this category, preceded only by the UK, Taiwan and Japan.

Furthermore, from a survey conducted by the World Economic Forum it resulted that the two main problems encountered by businesses in Malta were “Inefficient government bureaucracy” (25.4% of all responses) and “Access to financing” (14.4% of all responses).

These figures speak for themselves. Considering the fact that Malta’s economy is classified as being in the third and final stage of development, that is, it is considered to be Innovation driven, it is high time that a reform programme is agreed among the stakeholders starting this winter. One cannot forget to mention the skills mismatch which medium sized operators are facing when they decide to expand.

As stated by ECB executive board member Sabine Lautschläger, companies, especially SMEs, require a banking sector which is not risk-averse just because the ECB has tightened on regulation. Businesses need a banking framework which will not pull the plug simply because companies show minimal downturns in growth.

At a public consultation meeting last month the prime minister hinted that plans are under way to set up a Development Bank. He explained that there is a clear gap between the services offered by commercial banks and the current business needs, a gap which the Governor of the Central Bank himself stated could be effectively filled by means of a development bank. Countries such as Russia, Croatia and Turkey have made use of their own Development Banks in order to overcome the obstacles encountered by enterprises in obtaining credit. Why shouldn’t Malta be able to do the same?

Jaromir Sant is a trainee Statistician at PKF Malta an audit and business advisory firm.