How have SME finances been affected by the credit crisis?* BERR/ESRC Seminar: SME Access to Finance Dr. Stuart Fraser Centre for Small and Medium Sized Enterprises Warwick Business School *This research was funded by ESRC grant no. RES and with support from Barclays Bank.

2Warwick Business School Context ‘Over the last 18 months, and with increasing intensity over the last 6, the global financial system has suffered its greatest crisis in more than 70 years.’ Financial Risk Outlook, 2009: FSA. FSB report… Almost half it’s members have found it harder to gain access to finance in 2008: ‘The banks are upping the ante, they want guarantees of fixed assets, houses – they won’t take any kind of risk’. Stephen Peters (start- up bike-shop entrepreneur): The Guardian, 3/1/2009. Small firms affected by interest rate hikes and poor treatment despite good credit histories: ‘3 years ago [the interest rate] was 4.5% above the base rate but has risen to 11% above the base rate’. Inconsistent behaviour by banks (strategic vs branch level): ‘It [a £1bn HSBC small firms fund] is all rhetoric…I am not very hopeful’. Stephen Peters (commenting that his bank’s lending criteria had not changed). BBA report… Small business lending growing up to Sept 2008: overdraft lending up 4% over the year (but falling in Oct/Nov 2008); term lending up 10% (levelling out in Oct/Nov 2008). Who’s right?

3Warwick Business School UKSMEF 2008 Fieldwork 10 th Sept – 20 th Nov ,500 SMEs (up to 250 employees) interviewed in detail about the business/owner, sources of finance and financial relationships. Follow up to previous UKSMEFs in 2004 and 2007.

4Warwick Business School Hypotheses H1: Tightening of lending criteria has led to an increased likelihood of loan rejection in Riskier firms (start-ups, poor credit ratings, fewer assets, less experienced owners etc.) most affected. H2: SMEs have a higher likelihood of default in Tightening of lending criteria leading to lack of finance (e.g., working capital) and an increased risk of insolvency. Effect of credit crisis on real economy (reduced demand). Increased PD leads to higher capital requirements under ‘pro- cyclicality’  further tightening of new lending.

5Warwick Business School Credit crisis and recession affecting business problems…

6Warwick Business School and SMEs are more likely to default in 2008…

7Warwick Business School Summary analysis of changes between 2004 and 2008 in… Use of financial products Capital demands Loan rejection rates Discouragement rates

8Warwick Business School Lower use of financial products in 2008…

9Warwick Business School This reflects a fall in demand…

10Warwick Business School and a rise in rejection rates…

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14Warwick Business School Also, a significant increase in discouragement…

15Warwick Business School Multivariate analysis: impact of the credit crisis on loan rejection rates Amongst firms with capital demands, compare rejection rates for loan applicants in 2008 with otherwise identical non-applicants in 2008 (the counterfactual). Analysis controls for: turnover; assets; business age; sector; DB risk rating; region; main provider of finance (BIG 4 or other); owner's business experience; gender; and ethnicity. The difference in rejection rates is a measure of the impact of the credit crisis. Measures the change in the likelihood of rejection, for a given type of firm, in Analyze multiple impacts of the credit crisis depending on the type of firm.

16Warwick Business School Impacts of the credit crisis: overdrafts Average SME 23% (1.8% pts) more likely to be rejected in 2008 (7.6% (pre-2008)  9.4% (2008)). Most affected firms/entrepreneurs (% more likely to be rejected): High risk rating (39%) Low assets (£10K) (72%) High credit demands (sales=£10m) (139%) Low business experience (1 year) (466%) Big 4 banked (65%) Female owned (112%) Manufacturer (460%) Retailer (231%) Unaffected firms: Low risk rating Assets of £500K or above Low credit demands (sales of £100K or less) High business experience (15 or more years)

17Warwick Business School Impacts of the credit crisis: term loans Average SME 140% (6.7%pts) more likely to be rejected in 2008 (4.8% (pre-2008)  11.5% (2008)). Most affected firms: High risk rating (194%) Start-ups (694%) Black owned (480%) Low assets (£10K) (375%) Real Estate, Renting and Business Services (520.1%) Hotels and Restaurants (223%) Least affected firms: Low risk rating (65%) Assets of £5m or above (0%) Manufacturer/retailer (0%)

18Warwick Business School Conclusions Availability of both overdrafts and term loans affected by the credit crisis: Term loans most affected. But no evidence that banks have ‘stopped lending’: rejected firms still in the minority. Firms/entrepreneurs most affected by the credit crisis: Low assets (lack of collateral). High credit demands. Poor credit ratings. Low business experience/start-ups. Insolvencies likely to increase further in 2009 This may reduce lending further under ‘pro-cyclical’ capital adequacy rules. Turner Review considering new rules on capital adequacy.

19Warwick Business School Serious consequences of loan rejection in 2008…

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