Why Bankers Don't Want to Lend to Your Local Hair Salon

(Bloomberg Opinion) -- It’s hard to overstate the importance of small and medium-sized enterprises, or SMEs, to Europe’s economy. They make up 99% of all non-financial businesses in the European Union (by number) and account for about two-thirds of private-sector jobs. Their survival through the coronavirus lockdowns is essential. So is their swift return to health once people can get back to daily business.

Hence the speedy government measures to alleviate the SME cash crunch. Within days of cutting back economic activity, policymakers rolled out plans to disburse hundreds of billions of dollars to keep companies alive, packages that would typically take months to hammer out. But designing state-funded schemes that get the money where it’s needed quickly is a huge challenge. The evidence so far suggests that, while banks can help facilitate this process, there’s a limit to how much of the financial burden they’re prepared to take on. And their reticence is understandable. 

The long-term consequences of policy errors could be severe. Propping up companies that face a long-term solvency threat beyond the coronavirus outbreak will merely delay the inevitable; and loading up firms with yet more debt could hold back their recovery.

Getting financing to SMEs is hard at the best of times. Banks are typically reluctant to lend without borrowers’ pledges of collateral, and the costs involved are high, especially for young companies. In Europe, lenders have been given incentives to lend to SMEs by being told they can set aside less of their capital to cover their overall loans. But many banks are only just recovering from the last “bad-loan” crisis, and they still see huge risks in the SME world. Even when government guarantees are in place, they would still like collateral on their loans from the company concerned.

While Europe’s governments looked first to the banks to help mitigate the economic carnage cause by coronavirus lockdowns, the limits of what the industry was prepared to take on has become apparent.

Take the U.K. Of the 130,000 applications submitted by SMEs as of last week, only about 1,000 have been approved, totaling a paltry 90.5 million pounds ($112 million). Under the terms of the country’s Coronavirus Business Interruption Loan Scheme, lenders have been told they cannot demand personal guarantees for loans below a certain threshold, a requirement that had rightly incensed borrowers.

British banks will be on the hook for 20% of the coronavirus scheme’s loans, with the government guaranteeing the rest, and any losses will probably be shared proportionally from the outset. Other countries have taken the view that this is too much to ask of their lenders.

From the EU to the U.S., other national policymakers have concluded that their banks can offer little more than their processing services to get money to companies fast. Expecting them to take on the credit risk for 10% or 20% of the loans is seen as unrealistic when borrowers might run out of cash within weeks.

Following guidance from the EU that member states could back 100% of these loans for up to 800,000 euros ($870,000), Germany this week presented a new “limitless” loan program for companies with between 11 and 250 employees. Italy will start offering similar.

Switzerland’s SME program has been a model, including a first tranche of loans that are backed fully by the government for up to 500,000 Swiss francs ($514,000). Companies have been receiving funds within hours. A second tranche can follow with an 85% state guarantee.

However, it’s not just banks who need to be careful about the danger of non-performing loans. Governments do too when they’re loading up on debt, especially Europe’s weaker economies. While keeping companies alive is essential, policymakers need to keep weighing up the longer term implications. Rather than letting banks off the hook completely, an alternative would be providing longer-dated debt where lenders share the risk.

After all, not all businesses will survive and the banks can help be a little more cool-headed about assessing to whom that might apply — notwithstanding the inevitable howls of political anger that may be forthcoming. For example, the retail sector was already struggling with the dominance of Amazon in pre-Covid-19 days, and casual dining chains also faced severe challenges. Lenders should play a role in working through businesses’ probable chances of success.

There’s also a risk in the current approach of handing out loans to companies based on a percentage of their sales. That may work for some industries, but it might leave companies that principally trade goods — whose revenues are often much higher than their profits — with too high a debt burden. One size does not fit all.

Governments are doing the right thing by rushing to meet the funding needs of business through the shutdown. Which companies exit the crisis, and how, will need equal attention.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

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