DCU Business School Financing of businesses in Ireland before and after the credit crunch Valerio Potì Lecturer in Finance and Director of the Master in Finance & Capital Markets, DCUBS

DCU Business School Plan Main focus on SMEs Some facts and figures, key developments Implication for businesses/policy

DCU Business School Wealthy Days Is available financing sufficient to see projects through?, 2005 EOS Gallup SMEs Survey)

DCU Business School Fast forward to 2009 Unfortunately, no recent Gallup survey available Mazar’s report shows significant fall in loans to SMEs, but also in applications for loans Central bank data shows fall in lending across the economy (-3.6% yoy), especially dramatic in certain sectors (e.g., construction -28% yoy, manufacturing -18% yoy), but part of this is due to valuation effects (write-downs) No such falls in countries already less awash with credit (e.g. Italy and Germany) before ‘credit crunch’

DCU Business School Background / big picture Three crucial developments: –Transition to Basel II/CRD3 –Long-term trend towards recapitalization of banks –Burst of asset pricing bubbles

DCU Business School Basel II A much more risk-sensitive framework –Incentives to strongly discriminate across financed units based on measurable creditworthiness –Adverse effect mitigated by recognition of the diversification benefit afforded by lending to SMEs –Difficult to predict the final net effect, but better rated banks will be able to maneuver more

DCU Business School Banks replenishing capital cushions

DCU Business School Long-term view on capitalization

DCU Business School S&P500

DCU Business School (Re-)Emerging financing gap SMEs financing is naturally ‘problematic’ –They exhibit more volatile returns (distress risk) and there is a so-called “lemon problem” (information asymmetries + adverse selection), compounded, in the case of ISMEs, by lack of collateral Impact of these problems on both cost and availability of credit is exacerbated (relaxed) when banks need/want to hold more (less) capital as a cushion against risk The asset price bubble, and resulting credit bubble, simply concealed these problems for some time

DCU Business School ‘To-do list’ for SMEs Understand Basel II/CRD3, in certain cases cost of finance might actually decrease Effective communication with providers of capital, to reduce ‘opacity’ Manage working capital and volatility of cash flows –cash flows stabilization is a key tangible signal when negotiating creditworthiness Engineer liabilities in ways that minimize ‘ lemon problem ’, opportunity for financial engineering to rehabilitate itself

DCU Business School Possible policy measures Financial support and incentives to banks that lend to SMEs, e.g. EIB loans Schemes that facilitate credit to SMEs with risk-sharing, e.g. KfW in Germany, and an element of mutualism, e.g. the ‘Confidi’ funds/coops in Italy In Ireland, main focus has been on provision of seed and venture capital to “innovative” firms (ISMEs) Re-run survey like Gallup (money well spent)

DCU Business School Conclusions Because of long-term trend in bank capitalization, businesses will have to adjust to operating with lower levels of debt and higher levels of risk capital (own funds + arrangements that limit downside) If a growing SMEs sector is a policy aim, measures to close the likely widening ‘financing gap’ will have to be devised All the more important if the aim is to expand the indigenous business sector (without credit, typical option to finance growth for ISMEs is MNCs buy-out of entrepreneur)

DCU Business School End Merry Christmas!