20 August 2015

VoxEU: Estimating the financing gap of small and medium-sized enterprises

Why worry about the financing of small and medium-sized enterprises (SMEs)? In recent years, SMEs appear to have been severely underfunded (Beck et al. 2014). Firms with fewer than 250 employees are important players in all sectors within an economy. In Europe, there are more than 21 million companies in the SME sector, employing nearly 90 million individuals and thus contributing significantly to total job creation. Table 1 provides a definition of SMEs. In Europe, the percentage of employed persons working for SMEs lies between 60 and 70% (Lopez de Silanes et al. 2015).

The SME sector is thus significant for both economic growth and employment, which consequently implies that when the SME sector is negatively affected, economic growth and employment suffer. Indeed, relative to larger firms in the economy, the sector is extremely sensitive to external market shocks: severe economic conditions or changes in economic regulations. Some of the main causes of higher sensitivity are risks associated with small-scale businesses, lack of experience, low productivity, having a primary focus on local markets, and the naturally high rate of bankruptcies. The direct consequence of higher sensitivity to external market shocks is limited access to short- and long-term financing. That is an important reason for the further investigation of the financing constraints affecting the SME sector.

An important focal point of prior research on SMEs is to understand their dependence on credit and cash flow. SMEs face numerous obstacles in borrowing funds because they are small, less diversified, and have weaker financial structures. Indications that SMEs are financially constrained are: payment delays on receivables, declining liquidity, and an increase in SME insolvencies and bankruptcies. Besides the market signals that make SME sector firms unfavourable borrowers, SME firms find it difficult to provide high quality collateral at all times or insure transparency with respect to their creditworthiness (Ayadi and Gadi 2013).

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Concluding remarks

The financing gap for SMEs in Europe is substantial. There are several ways in which governments can contribute towards improving the flow of debt and equity to SMEs: providing knowledge about alternative forms of financing, improving loan support and guarantees, enhancing access to long-term financing and promoting non-bank financing alternatives. The Capital Markets Union can play an important role in the provision of equity (better disclosure and listing rules) and debt (introduction of private placement markets).

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