How have SME finances been affected by the credit crisis?*

BERR/ESRC Seminar: SME Access to Finance

Dr. Stuart FraserCentre for Small and Medium Sized

EnterprisesWarwick Business School

*This research was funded by ESRC grant no. RES-177-25-0007 and with support from Barclays Bank.

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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?

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UKSMEF 2008

Fieldwork 10th Sept – 20th Nov 2008.2,500 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.

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HypothesesH1: Tightening of lending criteria has led to an increased likelihood of loan rejection in 2008.

Riskier firms (start-ups, poor credit ratings, fewer assets, less experienced owners etc.) most affected.

H2: SMEs have a higher likelihood of default in 2008.

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.

Loan approval thresholds

H2 →

Probability of Default

Pre-2008 2008

← H1

Default Risk Distribution

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% of Businesses Experiencing Serious Problems

5.6%

8.1%8.8%

6.4%

18.1%

6.2%

10.5%

5.5%

11.5%

9.4%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

Production Getting orders Staffing/Personnel Finance Red tape

Percentage with serious problems (score>7/10)

20042008

Credit crisis and recession affecting business problems…

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and SMEs are more likely to default in 2008…

Dun & Bradstreet Risk Ratings

5.7%

31.9%

4.4%3.5%

11.5%

63.3%

21.7%

58.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

Minimal risk Low risk Average risk High risk

20042008

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Summary analysis of changes between 2004 and 2008 in…

Use of financial productsCapital demandsLoan rejection ratesDiscouragement rates

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Use of Financial Products

55.3%

52.9%

26.9%

24.3%

6.4%

3.0% 2.9%

37.3%

3.2%2.2%

5.7%

16.4%

20.5%

42.5%

54.4%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Credit Cards Overdrafts Asset Finance Term Loans Grants Invoice Finance Equity Trade Credit

20042008

Lower use of financial products in 2008…

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This reflects a fall in demand…% of Businesses with Capital Demands

59.1%

31.4%

3.3% 3.3%

50.2%

22.6% 23.5%

3.0% 3.9%

28.1%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

Overdrafts Term Loans Leasing and HirePurchase

Invoice Finance Equity Finance

20042008

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and a rise in rejection rates…Rejection Rates (Overdrafts)

7.2%

35.9%

16.3%

1.1%4.9%

1.6%4.2%

19.0%

10.9% 12.1%

20.4%

4.7%

17.1%

3.1%

8.9%

4.7%

15.3%

93.6%

9.9%

24.7%

10.0%

1.5%

14.3%

2.6%3.4%

6.1%

18.3%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

All less than10,000

10,000-49,999

50,000-99,999

100,000-249,999

250,000-499,999

500,000-999,999

1,000,000-4,999,999

more than5,000,000

Turnover

20042008Applied in 2008

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Rejection Rates (Term Loans)

7.4%

21.6%

10.1%

2.2%

9.2%

1.9% 2.1%0.5%

1.2%

9.4%

1.7%

13.1%11.2%

7.5%

11.6%

22.9%

1.5%

16.3%

13.5%

45.2%

16.6%

8.8%

26.8%

7.1%5.8%

1.0%1.5%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

All less than10,000

10,000-49,999

50,000-99,999

100,000-249,999

250,000-499,999

500,000-999,999

1,000,000-4,999,999

more than5,000,000

Turnover

20042008Applied in 2008

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Reasons for Rejection (Overdrafts)

17.6%

4.7%

11.5%

8.2%7.5%

0.3%

2.4%

5.4%

9.5%10.6%

12.1%

2.3%

4.6%

26.0%

4.1%

25.2%

1.8%

7.8%

5.3%

17.5%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

No Security InsufficientSecurity

PoorPersonal

CreditHistory

PoorBusiness

CreditHistory

No CreditHistory

Applied fortoo much

InadequateBusiness

Plan

Industry tooRisky

Lack ofProfitability

No Reason

20042008

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Reasons for Rejection (Term Loans)

4.0%

1.5% 1.5%2.5%

3.7%

5.2%

2.3%

4.1%

12.8%

4.0%

26.4%

2.1%

0.3%

15.7%

22.7%

14.0%14.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

No Security InsufficientSecurity

PoorPersonal

CreditHistory

PoorBusiness

CreditHistory

No CreditHistory

Applied fortoo much

InadequateBusiness

Plan

Industry tooRisky

Lack ofProfitability

No Reason

20042008

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Also, a significant increase in discouragement…

% Feeling Discouraged from Applying for Loans

3.9% 2.8% 3.7%

0.2% 1.2%

6.3%

19.0%

6.0%7.9% 8.9%

0.3%

9.8%

77.4%

14.7%13.4%

1.5% 1.0%1.4% 1.5%7.3%

5.4% 3.2%2.1%

0.2% 0.3%

6.4%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

All less than10,000

10,000-49,999

50,000-99,999

100,000-249,999

250,000-499,999

500,000-999,999

1,000,000-4,999,999

more than5,000,000

Turnover

20042008Loan Demands in 2008

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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 2008.

Analyze multiple impacts of the credit crisis depending on the type of firm.

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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 ratingAssets of £500K or aboveLow credit demands (sales of £100K or less)High business experience (15 or more years)

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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%)

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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.

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Serious consequences of loan rejection in 2008…

% Reporting Consequences of Rejection

58.5%

3.2%

28.7%

4.6% 4.1%

26.9%

11.5%

7.2%

47.1%

10.7%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

Not much - got fundingfrom elsewhere

Had to use internalfinance

Plans deferred buteventually went ahead

Plans dropped Business got into seriousdifficulties

20042008

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Rejection Rates (Overdrafts) by Region

11.1%

5.9%

12.9%

8.6%7.4%

1.5%0.4%

3.4%

5.6%

1.7%

18.6%

10.7%

4.1%

9.8% 9.6%

5.8%

9.8%

1.4%

36.1%

9.9%

0.7%

18.8%

11.2%

15.3% 14.8%

10.7%

18.4%

23.9%

16.9%

4.5% 4.0%

10.4%

6.0% 5.7%

19.5%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

London SouthEast

SouthWest

WestMidlands

EastMidlands

East NorthWest

Yorkshire NorthEast

Scotland Wales NorthernIreland

20042008Applied in 2008