SMEs are the backbone of the European economy – JP Morgan’s Perez comments
Cesar Perez is Chief Investment Strategist for J.P. Morgan Private Bank EMEA.
According to the European Commission, SMEs account for two-thirds of jobs across Europe and contribute to more than half of the total value-added created by businesses in the EU. The European recovery based on economic growth across the continent needs the full participation of SMEs, as they are one of the main drivers of wealth creation.
The EU already has several programmes in place to ensure that SMEs get funding support for research and innovation; there are also several national aid programmes which supplement European level aid. However, in a European environment where bank lending has been tight, access to finance has been problematic overall for smaller businesses.
European banks have delivered to the tune of €2.6trn since the peak of the crisis. Lending to SMEs has been hardest hit (they also make up the most of the periphery corporates, which have seen the strongest declines in bank lending). Growing numbers of eurozone larger companies bypassed banks and tapped bond markets; 2013 was the year of near record eurozone corporations issuance, many of those in the periphery and Greece.
As bond markets are not available as a funding resource for most SMEs and banks are still reluctant to lend across the eurozone, many of these companies have been shut out from financing and find it difficult to meet their cashflow and investment needs. In his December ECB conference, Draghi recognised that SMEs are struggling when it comes to getting credit. The ECB’s mission is to make sure that the liquidity it provides to banks through the LTROs reaches the real economy. Despite keeping rates low for long, this liquidity has not fed through to smaller businesses and consumers.
There were several options suggested for the ECB to solve this issue. One of them included the ECB buying asset-backed securities, with SME loans as underlying. However, SME backed loans are under €50bn, and the potential easing brought by this solution would not be significant across the euroarea. Furthermore, these instruments are not rated by the main rating agencies and would need additional risk checks, should the ECB add them to its balance sheet.
The EU did put in place an initiative to increase lending to the economy and are currently developing joint initiatives with the EIB in order to support SMEs. The advantage of the EIB is that it can offer favourable lending rates across the region, owing to its status as prime issuer in the capital markets. However, this initiative is still being developed and an immediate solution has not been found.
The main consideration for European authorities and the ECB is that there is easy access to funding across European SMEs. Therefore, we believe Europe needs a solution that does not only work for one country, but is feasible across the region. Funding the SMEs is not within the ECB’s direct mandate. The ECB is aware of the need of supporting the recovery with liquidity for all businesses and is more likely to take measures which deal indirectly with the issue. While buying SME-backed loans is not likely, the ECB could set conditions when giving further liquidity to banks in order to lend it out to the real economy and implicitly help the SMEs as well (perhaps similar to what the UK has done with the Funding for Lending programme).
We believe the ECB has the willingness to help the economic recovery in Europe. Lessening financial and fiscal headwinds should support domestic demand, which should be driven by SMEs and consumers across Europe. In terms of solutions, we believe the EU and ECB are aware of the importance of getting funding in the hands of the real economy. They are likely to directly target SMEs through regional programmes in partnership with supranational organisations such as the EIB and indirectly accompany any further liquidity disbursed to banks by conditions to lend funds out further in the economy.