VoxEU Column EU policies Financial Markets

Do all firms have equal access to external financing?

Small and medium-size enterprises (SMEs) often report difficulties in obtaining external finance. Based on new research, this column argues that these difficulties are not due to greater financial risks associated with SMEs. Instead, they are the result of imperfections in the market for external finance that negatively affect smaller and younger enterprises. The same research has shown that these types of firms are also the most reliant on external finance to support their investment and growth.

The proportion of bank loan acceptances has fallen significantly following the crisis, along with the level of enterprise investment. The sharpest falls in both have been in countries hardest hit by the crisis. While in a number of countries – such as Finland, Malta, and Sweden – the declines have been modest, in others – such as in Bulgaria, Ireland, Denmark, Lithuania, Spain, and Greece – they have approached or exceeded 30%.

Figure 1. Percentage change in bank loan acceptances

Note: The access to finance survey includes a subset of EU member states.
Source: ESRI analysis of Eurostat access to finance data.

The fall in bank loan acceptances has coincided with a fall in investment. The largest falls in investment from peak to trough have been in Greece, Latvia, Ireland, Estonia, Slovenia, and Lithuania. While much of the decline in investment can be attributed to poor macroeconomic conditions and a lack of profitable investment opportunities (EIB 2013, Kraemer-Eis et al. 2013a, 2013b), credit market developments may have played a role.

Figure 2. Peak to trough fall in investment, EU28


Note: The peak occurred during 2003–2007 and the trough during 2008–2013.
Source: ESRI analysis of Eurostat national accounts data.

As EU firms are heavily reliant on bank lending to support their operations, credit shortages can leave them vulnerable. Existing evidence indicates that a ‘financing gap’ or financial market failure occurs when viable projects cannot be financed due to financial market imperfections (O’Sullivan 2005, Oxera 2005, BIS 2012). This perceived ‘financing gap’ has been linked mainly to information asymmetries between lenders and borrowers (Oxera 2005, Hall and Lerner 2010, Peneder 2012, Moncada-Paternò-Castello et al. 2014).

Research findings

To identify the financing constraints enterprises face, and to test for the presence of financial market imperfections, an analysis was undertaken using the ECB SAFE data set.1 Actual and perceived financing constraints were measured for all types of firms, based on their direct responses, on credit applications and rejections, and on perceived financing constraints. In SAFE, data on credit applications covers bank loans, bank credit for working capital, trade credits, and other forms of external finance. Two time periods were analysed corresponding to the data available in the ECB/EC SAFE survey for all EU member states: April–September 2011 (H1 2011) and April–September 2013 (H1 2013).

  • The results from the analysis of the SAFE data set show that smaller firms face greater perceived and actual constraints compared to larger firms.

Credit rationing (rejection of credit applications) is the most common financing constraint.

Figure 3. Perceived and actual financing constraints, EU28

Source: ESRI analysis of ECB SAFE data.

In order to test for market imperfections, a bivariate probit model was constructed incorporating controls for financial performance such as turnover, profit, and credit history. The model was estimated on the same SAFE data.

  • The empirical results indicate that both actual and perceived financing constraints are higher for small and micro firms, with actual financing constraints decreasing with firm size and age.

These findings can be taken as an indication of market imperfections, which as noted above can be linked to information asymmetries. On the one hand, banks may not have sufficient financial information on firms who want to borrow, which is discouraging them from lending. On the other hand, firms may not have sufficient knowledge of potential lenders or may be discouraged from borrowing due to a belief that banks will not lend to them, so they will miss out on borrowing opportunities.

In order to examine the impact of external financing on firm growth, three econometric models were constructed to analyse the impact on investment, employment, and productivity. The models were estimated using the Amadeus data set, which includes information from the financial accounts of firms in Europe.

  • The main findings are that small and young firms are more dependent on external finance to fund new investment compared to other types of firms.
  • Also, small and young firms are more sensitive to the interest burden on borrowing, compared to other types of firms.

The results also showed that younger and smaller firms are being driven to accept shorter-term credit arrangements – possibly because they are having difficulty obtaining longer-term loans, which are more suitable for funding long-term investment projects. In terms of sectors, access to external finance is a more important driver of new investment in manufacturing and construction sectors than in services.

Long-term credit is very important to all firms for them to take on new staff. Domestic-owned SMEs and very small (micro) firms depend on long-term credit the most to expand their workforce. In general, rising firm productivity (total factor productivity) is strongly associated with increasing cash flows.

Using the EFIGE data set, a further model was constructed to examine the relationship between financial factors and exports.2

  • The results of the model revealed that firms that are less financially constrained are more likely to export, possibly because these firms have the available funds to overcome the sunk costs of entry into export markets.

However, financial constraints do not affect the export sales intensity of firms that are already exporting.

Policy implications

Because small and young enterprises suffer from imperfections in the market for bank lending, and they are also the types of firms that benefit the most from such lending to drive firm growth, there is a definite need to provide affordable, long-term credit to them. This need is reinforced by the fact that small and young firms are more sensitive to the interest burden on loans than other types of firms.

On the side of lenders, traditional policy support mechanisms such as loan guarantees, risk-sharing initiatives, and direct loan facilities can help small and young enterprises obtain credit. In addition, public support for other sources of financing for small and young firms – such as equity financing in the form of venture capital financing – also helps mitigate against the disadvantages that these firms face in the market for bank credit by diversifying the sources of finance available to them. Information asymmetries could be addressed by standardising the financial information on SMEs through the establishment of, for example, centralised credit rating agencies, on a national or EU level. These could be used as a source of reference by all banks, similar to the credit ratings issued on government, municipal, and corporate debt. On the side of borrowers, policy measures should be introduced that boost the market knowledge of small and young enterprises, as well as training in the preparation of loan proposals.

Improved access to external financing is likely to foster export participation over the long term. Specific policy measures to help companies to start to export could be in the form of export credits and insurance. This would represent a slight departure from current trade policy, which puts more focus on supporting existing exporters.

Given the variation in the severity of the financial crisis across countries, policy measures and instruments to improve SMEs’ access to external finance should take into account country specific conditions, i.e. priority should be given to policy support in those economies worst affected, whilst maintaining the need to support viable enterprises.

Authors’ note: This column is based on a chapter in the forthcoming 2014 European Competitiveness Report (http://ec.europa.eu/enterprise/policies/industrial-competitiveness/competitiveness-analysis/european-competitiveness-report/index_en.htm), to be published on 10 September 2014. It does not necessarily reflect the view or position of the European Commission.


BIS (Department for Business Innovation and Skills) (2012), “SME Access to External Finance”, BIS Economics Paper 16.

Hall, B H and J Lerner (2010), “The Financing of R&D and Innovation”, in B H Hall and N Rosenberg (eds.), Handbook of the Economics of Innovation, Volume 1, Amsterdam: Elsevier: 609–639.

Kraemer-Eis, H, G Passaris and A Tappi (2013a), “SME Loan Securitisation 2.0: Market Assessment and Policy Options”, Working Paper 2013/19, European Investment Fund.

Kraemer-Eis, H, F Lang and S Gvetadze (2013b), “European Small Business Finance Outlook June 2013”, Working Paper, European Investment Fund.

Moncada-Paternò-Castello, P, A Vezzani, F Hervás and S Montresor (2014), “Financing R&D and Innovation for Corporate Growth: What new evidence should policy makers know?”, Policy Brief, European Commission, Joint Research Centre – Institute for Prospective Technological Studies.

O’Sullivan, M (2005), “Finance and innovation”, Chapter 9 in J Fagerberg, D C Mowery, and R R Nelson (eds.), The Oxford Handbook of Innovation, Oxford: Oxford University Press.

Oxera (2005), “Innovation Market Failures and State Aid: Developing Criteria”, Report prepared for DG for Enterprise and Industry, European Commission.

Peneder, M (2012), “Firm Growth, Schumpeterian Entrepreneurship and Venture Capital”, in D J Cumming (ed.), Oxford Handbook of Entrepreneurial Finance, Oxford University Press: 424–466.


1 http://sdw.ecb.europa.eu/
2 http://www.efige.org/

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