Credit where credit's due

Small businesses may be the accidental beneficiaries of a European Central Bank bond-buying programme

Credit where credits due 974x296

For what seems a lifetime, policy-makers and regulators have worried over the issue of funding for small and medium-sized enterprises (SMEs).

Access to credit is a long-standing problem in most economies, and SMEs are heavily reliant on bank lending. Given that SMEs make up the backbone of the economy in terms of job creation, output and innovation, this acts as a constraint on economic progress. Furthermore, big companies start small: tomorrow’s giants are among today’s SMEs that get the right backing.

There has been no shortage of attempts by authorities in different countries to boost the flow of credit to SMEs. Some have involved the public sector sharing the risk of lending to smaller businesses, or providing commercial banks with public funding on condition that the borrowers will be SMEs.

Coming from another angle, investors have been offered tax breaks to buy shares in smaller enterprises, including generous write-off provisions for ventures that do not work out and exemptions from taxes on capital gains.

In all cases, the results have been mixed, to put it mildly, not least because policy-makers are forever closing what they consider to be loopholes opened up by the different incentives that they created.

Now, however, it seems that the euro-zone may inadvertently have hit on an effective, if roundabout, partial solution to the problem as a by-product of the European Central Bank’s Corporate Sector Purchase Programme (CSPP). Put simply, our research suggests that when the ECB buys bonds issued by big companies under the programme directly at their issuance, the effect is to deprive the banking sector of a sizeable piece of the lending business, prompting the affected banks to seek out new customers in the small business sector.

As we shall see, however, whether these new banking relationships have a long-term future is another question, as is the issue of whether the benign effects of the CSPP could be replicated to the lasting benefit of SMEs.

What is the CSPP?

The programme was launched by the ECB in June 2016 to increase inflation, in response to the sovereign crisis in Europe and following the 2007-2009 financial crisis. Previous measures had included negative interest rates and the purchase of certain debt instruments issued by banks. 

“Even in the post-crisis atmosphere of ‘quantitative easing’ and talk of ‘helicopter money’ dropped from the sky to stimulate demand, this was a controversial move”

Faced with the need for further monetary stimulus, the ECB, through the CSPP, committed itself to purchasing corporate securities in the secondary and critically, the primary markets. Even in the post-crisis atmosphere of “quantitative easing” and talk of “helicopter money” dropped from the sky to stimulate demand, this was a controversial move.

While it was an ECB operation, the actual purchase of the bonds was delegated to six national banks within the euro-zone – those of Germany, France, Italy, Finland, Spain and Belgium, depending on the geographical location of the bond issuer. This is important because it helps us to identify the affected regions as well as the affected industries in our analyses.

The ECB set the criteria for bond purchase understandably high, one of them being that that the bonds be rated “investment grade” by leading credit agencies such as Standard & Poor’s or Moody’s. Other requirements included that the bonds be euro-denominated, have remaining maturities of more than six months, be issued by a company incorporated in the euro-zone (albeit the parent company could come from outside the single-currency area), and that it be issued by a non-financial corporation that was not subject to banking regulation.

By 2019, corporate bond purchases by the ECB totalled more than €178 billion  (£151 billion), an intervention large enough to affect the market as a whole, rather than simply alter the borrowing arrangements of some individual companies.

The net effect was that many European banks were now in the position of seeing some of their most creditworthy corporate borrowers, with whom they had in many cases enjoyed long and profitable lending relationships, being directly funded by the ECB. On the other side, presented with a ready buyer for their debt in the shape of the ECB, big corporations needed little encouragement to substitute bond issuance for bank loans, consolidating the trend.

How did the banks respond? Our research suggests that banks increased their exposure to SMEs by 12% compared with their position before the CSPP. It is important to note that there was nothing inevitable about the banks’ behaviour in this regard. While the CSPP deprived them of some business, the funds it made available could have been used for purposes other than SME lending – for dividends to shareholders, or mortgage lending, for example.

Given that the choice in so many cases appears to have been an increase in SME credit, it is worth asking why the affected banks did not choose to lend to small businesses before the bond purchase scheme came into operation. A clue here may lie in the fact that the strongest results in terms of increased SME funding came from banks that before CSPP were experiencing liquidity-constraints (a shortage of loanable funds). This is an indication that the effect of the programme was to free bank funds for alternative customers, in the shape of SMEs.

A key concern in recent years has been that negative ECB rates might have prompted banks to seek returns by lending to inherently riskier borrowers. Is that what is happening here? We do not believe so, since there is no evidence of a higher level of non-performing loans to the SME sector on the books of banks affected by the CSPP than in those not  affected.

“The authorities have stumbled upon what would appear to be a powerful mechanism for channelling much-needed funds to SMEs”

There could have been two alternative explanations for the increase in SME lending. One would be that the CSPP targets booming regions and industries and the increased lending could be explained without recourse to notions of funds diverted from big-business customers. The other is that, in strengthening the large companies with which SMEs do business as suppliers or contractors, the CSPP indirectly bolsters the SMEs too, making them a more attractive prospect for lenders. Again, this would explain the lending rise without the need for our own proposition. But our research shows that these explanations fall short. 

In the first case, while we do observe that small businesses’ chances of securing a loan increased by 4% in the regions affected by the programme,  after screening out possible distortions, we found that the CSPP nonetheless explains a significant proportion of the increase in SME credit. In regards to the second concern, if SMEs were accessing more credit based on improved business fundamentals, we would expect such businesses to express confidence in all types of outside financing, not just bank lending, which was not the case. We also ruled out the possibility that the results could have been due to other ECB policies.

Overall, we found that SMEs in regions and industries affected by the CSPP were 20% more likely to get credit and establish new banking relationships – a highly positive development which is only underscored by the positive use to which the borrowers put their increased funding. SMEs are more likely to increase capital investment and hire more workers than they are to use the extra funding to supply working capital or to refinance existing debt.

Does it mean that this particular type of “financial disintermediation”, with direct central-bank lending to corporate borrowers, by-passing commercial banks, is the solution to the long-standing problem of SME access to credit? Could it somehow be made permanent? Indeed, has it already wrought structural changes in the bank-SME relationship that will endure?

As a one-off, the answer seems to be no. Our research initially examined the effect of the CSPP right after its launch, measuring its impact as a “policy shock”. However, when we looked at its effects over a longer period, they fade in significance and eventually disappear.

Need that be the end of the story, however? The authorities have stumbled upon what would appear to be a powerful mechanism for channelling much-needed funds to SMEs. It would be extraordinarily wasteful to allow it to wither on the vine. As the ECB president Mario Draghi noted in June 2017, “the fact that large corporations rely more on funding from bond markets leaves more space in the balance sheet of banks to provide loans to SMEs. In addition, lower bond market rates reduce funding costs for banks and thus allow them to provide cheaper funding to SMEs.”

We know from the CSPP experiment that a buoyant market for investment-grade corporate bonds both frees up bank funds for lending to SMEs and gives banks the incentive to seek out smaller business customers. That is surely a promising starting point for any attempt to translate the temporary and serendipitous, but highly significant, lift to SME funding from the CSPP into a more permanent solution to a problem that has resisted resolution for as long as anyone can remember.

Taken from “Financial intermediation through financial disintermediation: Evidence from the ECB Corporate Sector Purchase Programme, by Aytekin Ertan, London Business School, Anya Kleymenova, University of Chicago Booth School of Business, and Marcel Tuijn, University of Notre Dame and Rotterdam School of Management, Erasmus University.


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