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Monthly Report - DossierAvelino Hernández, Maria Pilar Buil Vilalta
SME financing in Spain: short-term emergency, long-term challenge

Financing small and medium-sized enterprises (SMEs) constitutes a core element in the complex panorama facing Spain's economy. At the forefront, the crisis that started in 2008 has led to severe financial restrictions that have hit SMEs particularly hard. As a background, for the last few decades Spain has been suffering from a structural problem in how to ensure an appropriate supply of financing for firms taking on the challenge of growth. This has merely contributed to the endemic problem of our business fabric's insufficient size.(1) Certainly, the alarming situation of the crisis is stimulating a range of reactions by private agents and authorities, looking for solutions to the pressing problem of the lack of liquidity. What is urgent in the short term must not, however, divert attention from what is important in the long term. Specifically, the measures now being adopted should include mechanisms that improve the prospects of Spanish SMEs expanding. This necessarily involves reinforcing those channels and instruments that provide long-term financing (which allows business to be expanded, either by investing in new plant or establishments or by acquiring other complementary or rival firms).

The graph below presents data on the business financing structure by size in Spain and other similar countries.(2) It helps to illustrate three stylized facts that have been amply verified on many different occasions. The first is that small firms essentially rely on self-financing and, when they grow, external financing tends to become more important.(3) The second is that debt is the dominant source of external financing for SMEs, more so than capital instruments. The third is that the basic type of debt for these firms is a bank loan, which gradually gives way to capital market financing as they grow in size. Spain is a good example of these patterns, of note being the relatively smaller proportion of external financing and, within this, the notable prevalence of bank loans, all this in parallel with the smaller size of its firms. Some questions come immediately to mind: what lies behind these stylized facts? Can this dynamic be improved? And, if so, how?

On a conceptual level, there are two fundamental elements in play that explain the difficulties or obstacles faced by small firms in accessing external financing. The first is that they face a more severe problem than large firms in the form of «information asymmetry» between potential financers and the entrepreneur/manager; i.e. a problem of opacity (typically combined with less capacity to offer guarantees) that hinders financing or makes it more expensive. This is particularly important when the aim is to resort to the capital markets and somewhat less so when bank credit is used, insofar as suitably prepared banks can monitor and control the company in question. The second element is strictly the issue of scale: the cost of some external financing instruments is so high that they cannot be used for low volume operations. This is the case of the costs (due to legal, commercial, administrative procedures, etc.) of issuing bonds on the capital market, and even more so in the case of going public. In addition to this kind of factor related to «supply», there are also important factors that limit «demand», particularly the reticence of many small-scale entrepreneurs to accept what they see as interference in the company's control.

Numerous studies have documented that removing the obstacles to financing benefits both the economy and society as a whole.(4) More specifically, one widely accepted conclusion(5) is that it is highly beneficial to broaden the financing options for SMEs, especially helping them to access stable long-term resources, from a wide range of suppliers and in terms of both capital and debt (thereby helping to optimize their liability structure in accordance with developing conditions and in step with their growth). This observation is particularly relevant for Spain with its current far-reaching reforms of its financial sector, as there is now the chance to correct the inefficiencies and deficiencies that have been accumulating regarding both the regulations and the practices of private agents.(6)

It is also a good idea for SMEs to do their utmost to improve the transparency of their business with regard to potential financers. The direct way is by communicating their strategy, providing their audited accounts, reporting on relevant facts, etc. Indirectly they should professionalize their management and improve their corporate governance practices. Including independent members on the Board or shareholders with a good reputation usually sends out a positive signal to the rest of investors and lenders. On the other hand, instruments that help to broaden the possibilities of offering guarantees (such as mutual guarantee societies) could be used more widely. Authorities should design regulatory reforms while bearing in mind, at the same time, both the pressing short-term needs and long-term challenges. In this respect, bank and capital markets (shares and bonds) are areas that should complement each other to allow SMEs' expansion to be financed under satisfactory conditions.

With regard to bank channels, it is advisable to ensure that the combined effects of the many different reform initiatives in response to the crisis do not lead to perverse incentives with regard to the financing of SMEs with the potential to grow. One decisive area is the structure and configuration of the sector. The «universal relationship banking» model has proved to have advantages: having a group of organizations with an extensive set of connections in the field (and therefore close to firms), as well as financial muscle and know-how, helps to support SMEs in their growth, offering them a wide range of products and services (from those befitting commercial banking to those more associated with investment banking). And all this while also cultivating trustworthy relations in the long term. It would therefore be a good idea for reforms to preserve this model. Another important source is prudential banking regulation (solvency and liquidity) as tougher regulations threaten the supply of credit in general and for SMEs in particular. Some of the elements in this regulation may be very important, such as the maximum size in order to be considered an SME, which should be increased.(7)

With regard to the capital markets, authorities' actions should be aimed at helping SMEs to access these under reasonable conditions: removing barriers and reducing costs being the objectives. Bond markets have traditionally been the hunting ground of large firms due to the aforementioned reasons. This has become a privilege as international corporate bond markets have remained enviably strong during these last few years of financial crisis in contrast to the lethargy of bank credit. Although its starting point is not very promising, Spain could join the efforts being made by various countries to help their SMEs break into these markets. The United Kingdom is a case in point, with projects such as the creation of agencies that centralize and aggregate issuances.(8) Similarly, the recent creation of the SEND platform for electronic bond trading is an instrument that could be of great help in achieving this aim.

Equity markets are a terrain that is better known but not often frequented by Spanish SMEs. Here we need to distinguish between two broad areas: the alternative stock market (MAB in Spanish) and private equity. In 2008, MAB Expansión was set up, a segment specifically conceived for growing companies. The results are promising but still far from their true potential. It is necessary to continue this effort via informative actions and by relaxing the requirements for access wherever possible.(9) Spain's private equity also has a lot of room for improvement, especially in the critical segment of development capital. The list of measures that might further this development is long but, at present, the most useful measures would not be related to the private equity entities or funds themselves but to the rest of the agents involved. Firstly, it's crucial to change the predisposition of small entrepreneurs, encouraging more open attitudes regarding corporate governance and shareholder control. Secondly, stimulating the sources of ultimate financing of private equity entities, for example via investment or pension funds or insurance companies.

All these considerations in no way constitute an exhaustive list but they do help us to appreciate the broad scope of action for public policies and private initiative in the area of SME financing, particularly regarding the challenge of boosting their long-term growth.

(1) See the box «Companies and productivity: a matter of size» in this issue.

(2) Taken from O. Arce, E. López and L. Sanjuán, «El acceso de las pymes con potencial de crecimiento a los mercados de capitales», Documento de Trabajo no. 52, Comisión Nacional del Mercado de Valores (CNMV) (2012).

(3) This circumstance cannot be duly appreciated in the graph as «net equity» includes both those resources generated internally as well as those gained externally (stock market, private equity, etc.).

(4) Of note are the pioneering contributions of R. Levine, «Finance and Growth: Views and Agenda», Journal of Economic Literature, Vol. 35, (1997) and that of R. Rajan and L. Zingales, «Financial Dependence and Growth», American Economic Review, Vol. 88, (1998).

(5) See T. Beck, A. Demirguc-Kunt, L. Laeven and R. Levine, «Finance, Firm Size and Growth», Journal of Money, Credit and Banking, Vol. 40, (2008).

(6) The talks can be consulted at the «Seminario sobre la Financiación de las Pymes» held by the Bank of Spain and the Comisión Nacional del Mercado de Valores (CNMV) in February 2012. Also the monograph «Pyme: impacto y retos de la crisis en su financiación» by the Fundación de Estudios Financieros (2012).

(7) See Bank of Spain Circular 3/2008.

(8) «Boosting finance options for business», Report of industry-led working group on alternative debt markets, U.K. Government, March 2012.

(9) Even a country with such a developed stock market as the United States continues to promote leading initiatives, for example the recent «Jumpstart Our Business Start-Ups Act», which aims to ease the regulatory requirements for firms going public.

This box was prepared by Pilar Buil and Avelino Hernández

Research Department, "la Caixa"

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