BusinessNZ’s Phil O’Reilly on SME Financing – #G20SME

Phil O’Reilly, BusinessNZ Chief Executive, gives a New Zealand perspective on accessing business finance in his address at the G20 Agenda for Growth: Opportunities for SMEs conference on 20 June, 2014.

The challenge facing us post-GFC is to unlock greater growth. Reforms that unleash private sector activity, in particular for SMEs, will be essential.

SMEs account for enormous shares of employment and value-added. In my own country, New Zealand, 97% of all firms employ 20 workers or less. SMEs invest, innovate, and create jobs. In Europe, they provide for two out of every three jobs. SMEs are the lifeblood of our economies.

Financing SMEs takes different forms, with striking regional variations. Banks account for around 75% of business financing in the European Union, while they only account for about 10% of business credit in the US. Similarly, with relatively small capital markets, emerging economies tend to be more bank-dependent.

There is no one-size-fits-all approach for SME financing and much depends on national or local economic contexts. Nevertheless, for many economies around the world, we need to raise the level of finance in the economy to support our growth aspirations.

SMEs’ difficulties in accessing finance: The impact of regulations

Appropriate financial regulation and policy initiatives are essential for the sustainability of our economies. The 2008-09 crisis was a dramatic wake-up call to the world’s regulators, leading to the internationally-agreed Basel III reforms.

However, now there is growing concern that the regulatory pendulum has swung too far the other way, and a wave of new financial regulations introduced by different jurisdictions at the same time may contribute to fragmentation and structural changes in financial services. The combined impacts could potentially impede global recovery and SMEs could be particularly badly hit.

Imagine you’re a small company. You may need a loan to survive and grow, but the banks have lost their appetite to lend to your business due to regulatory measures that prompt them to direct their financing elsewhere. You may also need other financial services to help you manage your risks (for example, managing your currency risk if you’re selling your product overseas), but some regulatory approaches have made this too costly.

Now, imagine you are the bank. You are under pressure to maintain reasonable returns to remain attractive to investors. However, you also face new rules on capital, liquidity, and many other aspects of your business model. So you are able to shoulder less risk than before. You are now faced with some tough choices. You may accept a new status quo of lower profits from here on, though that’s going to make it very hard to compete and attract investors. Alternatively, you may decide to pass on costs to your customers, though you may lose customers as a result. You may instead decide to shift capital away from activities that are relatively high risk and low-yielding – such as SMEs. In all likelihood, your decision might be a mix of all of these.

It is vital to ensure that reforms do not stand in the way of SMEs’ access to credit and other financial services. We need greater independent analysis of such possible impacts.

Role for alternative financing instruments

With traditional sources of financing less able to lend to SMEs, there will likely be a transition to a new, more diversified model in which alternative, innovative sources of financing play a much larger role than before in many economies.

As a small company grows, its financing needs change. Meeting these different financing needs through alternative, non-bank funding sources is often challenging for a small company. In the earliest stage, for example, it may be more suited to microfinance, friends and family, or business angels. As the company develops, it may then be more suited to venture capital, asset-based finance, or export credits. Private debt placements and securitisation might follow in due course.

In order to facilitate alternative sources of financing:

•  Reforms are needed in many cases to remove regulatory impediment e.g. to support market liquidity and securitisation.
• We need to improve transparency and reduce the costs of accessing information about SME creditworthiness and potential.

More education is needed for SMEs on available alternative financing.

While alternative financing should be encouraged, need also to be aware of the rise in so-called shadow banking, where unregulated and non-transparent financing sources may generate new problems of their own.

Traditional forms of finance – such as bank overdrafts and loans – will remain crucial. Instruments such as credit guarantee schemes and credit insurance could help banks to support SMEs in the near term without putting scarce capital at risk.

We need to overcome the stigma that has been associated with banking innovation since the crisis. All industries, including banking, need to be able to innovate in order to serve their customers better.

In conclusion, let me underline the following key recommendations:

• Economic growth and financial stability need to be dealt with at the same discussion table. This hasn’t been the case to date.
• There is a pressing need for independent analysis of the cumulative impacts of different financial regulations on our economies.
•  A more co-ordinated approach to financial regulation is needed – one that puts equal emphasis on economic growth, financial stability and investment.
•  We should undertake necessary reforms and initiatives to allow alternative sources to play their part in a more diversified landscape for SME financing.

Phil O’Reilly is Chief Executive of BusinessNZ, New Zealand’s largest business advocacy group, representing thousands of businesses of all sizes.

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