The bank-firm relationship after Basel II: a survey of italian firms Chiara Bentivogli, Emidio Cocozza, Antonella Foglia, Simonetta Iannotti Bank of Italy The views expressed here are those of the authors and do not involve the responsibility of the Bank of Italy

Why a survey (2006)? From 2007 Basel II in force From 2007 Basel II in force It is aimed to increase consistency between the equity level and the risk actually taken by intermediaries It is aimed to increase consistency between the equity level and the risk actually taken by intermediaries Will this new approach change the relationship between banks and firms? Will this new approach change the relationship between banks and firms?

Questions Expectations of (small) firms on Basel II Expectations of (small) firms on Basel II Costs and benefits of change Costs and benefits of change Effects on competition on credit markets and on SMEs growth Effects on competition on credit markets and on SMEs growth

Basel II: in theory Main purpose: a regulation more in line with the actual banking sector structure and best practices, more flexible options for banks Main purpose: a regulation more in line with the actual banking sector structure and best practices, more flexible options for banks Increase price discrimination and product variety Increase price discrimination and product variety Stimulate the exchange of more information (hard) between banks and firms and improve its use Stimulate the exchange of more information (hard) between banks and firms and improve its use

.... and in practice The final equilibrium depends on the level of expected benefits and costs… The final equilibrium depends on the level of expected benefits and costs… - perceived competitive pressure - number of credit relationships could increase or decrease (costs and benefits) - possible problems for start-ups and SMEs (nothing new) - in the worst case we could have an increase in “total financing costs” for firms

Italian SMEs (1) Average firm dimension in Italy: 4.1 workers in steady decline for 30 years Average firm dimension in Italy: 4.1 workers in steady decline for 30 years 97.9% of firms are small (<20 workers) 97.9% of firms are small (<20 workers) small dimension implies low productivity small dimension implies low productivity

Italian SMEs (2) Do not grow because they have external constraints Do not grow because they have external constraints Do not grow because they do not have enough incentives Do not grow because they do not have enough incentives Credit markets are part of the two types of factors Credit markets are part of the two types of factors - financial constraints - financial constraints - support and stimulus of firms with good prospects - support and stimulus of firms with good prospects

Can Basel II help to sustain SMEs growth? Yes: through competition, better screening, more accurate evalutation of firm’s project Yes: through competition, better screening, more accurate evalutation of firm’s project No: too much attention to retrospective data and to guarantees No: too much attention to retrospective data and to guarantees

Bank-firm relationships In bank-firm relationship there is a specialization by dimension In bank-firm relationship there is a specialization by dimension Basel II allows banks to better choose their strategic positioning Basel II allows banks to better choose their strategic positioning

Bank loans to private non agricultural firms (2005, %) Type of bank Small firms Other firms Total Small banks part of groups local banks other Big banks Total Total

Bank loans to private non agricultural firms (% of loans by type of firm) Area Small firms Other firms North-West North-East Centre South and Islands

Are Italian firms aware of the possible effects of Basel II? Less than 40% of firms in the national survey said they already knew Basel II and were aware of its effect on firm’s operations Less than 40% of firms in the national survey said they already knew Basel II and were aware of its effect on firm’s operations Knowledge of Basel II impact is higher among firms in the local survey (61.7%), but there is a high share of negative answers Knowledge of Basel II impact is higher among firms in the local survey (61.7%), but there is a high share of negative answers

Are Italian firms doing something in view of Basel II? About ½ of the firms which said that they knew the new regulation also declared that they had already adopted some initiatives to adapt to Basel II or had the intention to adopt them in the near future (49.6% national) About ½ of the firms which said that they knew the new regulation also declared that they had already adopted some initiatives to adapt to Basel II or had the intention to adopt them in the near future (49.6% national) The percentage is a bit lower in the local survey (43.9%) The percentage is a bit lower in the local survey (43.9%)

Are Italian firms doing something in view of Basel II? Only 20% of Italian firms with less than 20 workers adopted some initiatives in the view of Basel Only 20% of Italian firms with less than 20 workers adopted some initiatives in the view of Basel These results show that a limited share of firms perceives the introduction of Basel II as a relevant change in their relationships with banks, and that they need adequate instruments These results show that a limited share of firms perceives the introduction of Basel II as a relevant change in their relationships with banks, and that they need adequate instruments

Initiatives taken in view of Basel II Low transparency and undercapitalization are considered the main problems of the firms interviewed; they plan to tackle them through: Low transparency and undercapitalization are considered the main problems of the firms interviewed; they plan to tackle them through:  Further disclosure of information  An increase in capital/debt ratio - local survey: 61.2% of firms said they would increase the ratio by a rate ranging from 11 to 50%, whereas 12.2% of the respondents anticipated a raise of more than 50% - local survey: 61.2% of firms said they would increase the ratio by a rate ranging from 11 to 50%, whereas 12.2% of the respondents anticipated a raise of more than 50%

Do firms already notice some change in banks’ behaviour? No change: No change:  credit availability (62% of firms – national, 58% - local)  credit price and/or in the request of guarantees (73% – national, 67% - local)  length of credit inquiries and in loans’ maturity (more than 80% – national, local: length of credit inquiries: 46%; loans’ maturity 83%) (more than 80% – national, local: length of credit inquiries: 46%; loans’ maturity 83%)  request of information (71% – national, 74% - local) For credit availability and price, high share of firms that perceive either a reduction or an increase - New banks’ strategies?

Do firms plan to change some aspect of their banking relationship? (1) Change of the main bank (4.9% national; 24.8% local) Change of the main bank (4.9% national; 24.8% local) reduce the number of lending relationships (25.9% national; 32% local) reduce the number of lending relationships (25.9% national; 32% local) increase the number of lending relationships (10.4% national > 49 workers; 28.1% local) increase the number of lending relationships (10.4% national > 49 workers; 28.1% local)

Do firms plan to change some aspect of their banking relationship? (2) (local survey only) 3 banks/firm on avg (>5 for firms w/>49 workers) 3 banks/firm on avg (>5 for firms w/>49 workers) Main bank dominates credit relationship (57% of borrowing) Main bank dominates credit relationship (57% of borrowing) Why many banks? More credit, exploit competition among banks, each bank offers only a limited range of services, exploit different evaluations of the firm Why many banks? More credit, exploit competition among banks, each bank offers only a limited range of services, exploit different evaluations of the firm Emilia-Romagna: more stable relationships with intermediaries (13 years vs 7 years in Puglia & Basilicata) Emilia-Romagna: more stable relationships with intermediaries (13 years vs 7 years in Puglia & Basilicata)

Do firms want to grow? (1) (local survey only) 2/3 of firms think their size is adequate 2/3 of firms think their size is adequate This share rises to 80% in the South and decreases to 1/3 in Emilia-Romagna This share rises to 80% in the South and decreases to 1/3 in Emilia-Romagna

Do firms want to grow? (local survey only) 76.2% had considered the possibility of increasing the business scale during the last 10 years 76.2% had considered the possibility of increasing the business scale during the last 10 years In 81% of cases t he growth plan was carried out, but the accomplishment rate is higher in Emilia ‑ Romagna (91.2% against 79.0%). The % rises with firm size In 81% of cases t he growth plan was carried out, but the accomplishment rate is higher in Emilia ‑ Romagna (91.2% against 79.0%). The % rises with firm size

Main forms of growth financing (local survey only) Small firms: self-financing Small firms: self-financing Substantial geographic differences: Substantial geographic differences:  in Puglia and Basilicata self-financing is the more frequent form of financing  in Emilia Romagna about ½ of financing needs is satisfied through bank loans

What are the main obstacles to firms’ growth? (local survey only) The more important constraint is financial support The more important constraint is financial support Other relevant factors: financing costs, uncertainty of investment outcomes and difficulty of finding managerial staff Other relevant factors: financing costs, uncertainty of investment outcomes and difficulty of finding managerial staff Less relevant factors: governance problems and bureaucracy Less relevant factors: governance problems and bureaucracy

Role of the banks in firms’ growth? (local survey only) The main banks very often did not play a fundamental role The main banks very often did not play a fundamental role The majority of the firms pointed out that the main bank offered little or no support in terms of higher credit availability (28.6% no support; 56.2% little support) The majority of the firms pointed out that the main bank offered little or no support in terms of higher credit availability (28.6% no support; 56.2% little support) The adviser role played by the intermediaries is even less remarkable The adviser role played by the intermediaries is even less remarkable

Some final remarks Given the timing of the survey, the share of firms knowing something about Basel II was not negligible Given the timing of the survey, the share of firms knowing something about Basel II was not negligible Changes in firms’ organization and capital level are planned; not clear trend in number of lending relationships Changes in firms’ organization and capital level are planned; not clear trend in number of lending relationships The survey indicates as more likely the starting of a virtuous circle from the application of Basel II The survey indicates as more likely the starting of a virtuous circle from the application of Basel II The propensity to grow and bank support to firms’ growth vary across regions The propensity to grow and bank support to firms’ growth vary across regions Firms increasingly request to banks consulting services in addition to financial support Firms increasingly request to banks consulting services in addition to financial support

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