SMEs in Ireland: Contributions, Credit and Economic CrisisFergal McCann

Irish Economy Conference, Dublin 1st FebruaryDisclaimer: The views expressed here do not represent the official opinions of the Central Bank or Ireland or the ESCB

Domestic demand and particularly investment have fallen severely and are just showing signs of stabilising.(Source: CSO Quarterly National Accounts)

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Domestic Demand and Gross Fixed Capital Formation, 1997q1-2012q3. €m

Final DomesticDemand

Gross Domestic FixedCapital Formation(Right Axis)

• 2: SMEs in the real economy and the distribution of economic activity

The distribution of private sector employment(Source: CSO - CIP and ASI; Excludes Agriculture and Construction)

• SMEs are very important in private sector employment (72%)

• Domestic demand is crucial for employment (64%)

Different picture for Gross Value Added – the international sector is much more important. (Source: CSO - CIP and ASI; Excludes

Agriculture and Construction)

• SMEs account for 52% of GVA

• Domestic demand accounts for 33%

Exports and employment are not strongly related – “export-led recovery” as employment recovery???

• 3: SMES and the banking crisis

Direction of SME new lending – to which sectors is new lending going? 4-quarter average figures

to Q3 2012.

Key message – SME lending is realigning away from Real Estate lending (although share of stock of credit remains large at ~50%

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11. Real Estate Activities Non-Real Estate

Share of Stock

Share of New Lending

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Share of New Lending

• NB: “losing” sectors employ large amounts of people:

• Construction 98k

• Wholesale & Retail (including Motors) 330k

• Hotels & Restaurants 145k

SME Gross New Lending is not growing since 2010 (Source:

Central Bank; Money, Credit and Banking Statistics)

Given economic contraction, some correction to credit conditions was necessary and

inevitable. Has the pendulum swung too far? Credit decisions, 2007 and 2010, Eurostat

Access to FinanceAccept Partial Reject Accept Partial Reject

Finland 98.1 1.9 0 Finland 95.9 3.9 0.2Ireland 96.9 2.1 1 Malta 91.3 6.5 2.2France 94.5 3.6 2 Poland 85.4 10.3 4.3Malta 94.3 5.7 0 France 83.3 9.7 7Cyprus 93.2 6.8 0 Belgium 83.1 11.2 5.7Belgium 92.4 5.4 2.2 Sweden 79.7 14.1 6.1Poland 91.9 4.3 3.7 Italy 78.4 16.7 4.9Denmark 91.8 4.5 3.7 Cyprus 76.7 19.1 4.2Slovakia 89.3 7 3.7 Slovakia 76.1 14.7 9.2Lithuania 89.2 9 1.8 Germany 75.9 15.9 8.2Latvia 89 6.7 4.3 Luxembourg 68.4 20.9 10.7United Kingdom 88.4 6.1 5.6 United Kingdom 64.6 14.7 20.8Greece 87.6 11.7 0.7 Latvia 63.5 10.1 26.4Spain 87.3 9.7 3 Netherlands 61.3 16.2 22.5Bulgaria 87 9.9 3.1 Denmark 59.8 21.7 18.5Italy 86.6 12.2 1.2 Greece 59.6 29.6 10.8Germany 85.3 8 6.7 Spain 59.1 27.8 13.2Netherlands 84.3 8.9 6.8 Lithuania 58.4 20.4 21.2Sweden 84.2 7 8.7 Ireland 53.2 20.2 26.6Luxembourg 78.8 15.2 6 Bulgaria 42.5 22 35.5

The price of credit for SMEs – impact of deposit competition (in reaction to sharp fall in

external funding) on lending spreads for SMEs?

Covered banks offer higher deposits from

2010 onwards

Increased spreads for small firm loans are

driven by covered banks over same period.

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(c) Interest rates on new lending, loans <1million Euro

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Non-FMP banks deposit rate FMP-Banks deposit rateEuribor (3m)

• 4: Sources of the fall-off in credit provision

Supply and demand side factors are both at play in Ireland

• Supply

– Banks’ balance sheet problems

• High losses on non-performing loans and a need for more sustainable assets to liabilities ratio can lead to credit rationing.

• Changes in risk aversion post-crisis.

– Borrowers’ balance sheet problems

• High arrears, excessive debt levels and decreased creditworthiness can lead to loan rejection.

• Demand

– Excessive existing leverage – incentive is to lower borrowings, not accumulate more debt.

– Lack of aggregate demand for their output.

– Decreased investment and growth opportunities.

Balance Sheet Recession? (Source: Macro Financial Review, Central Bank)

• NB: MNCs account for large share of these numbers.

• Disaggregate data unavailable for SMEs or indigenous firms.

• Cussen and O’Leary (2012) highlight that 47% of GVA of Irish NFCs is from foreign firms.

• as a % of financial assets, Irish NFC debt is one of the lowest in Europe (under 50%).

• Almost 50% of NFC debt in Ireland is with non-resident lenders. MNC debt.

While Euro area NFCs appear in balance

Demand: Net % increase in need for external finance is falling; but remains around euro area average

Data: SAFE Surveyup to wave 7 (Sept 2012)

Change, Bank Loans Change, OverdraftCountry Net % Net % Country Net % Net %

Sep-12 Mar-12 Sep-12 Mar-12

DE -8.3 1.6 AT -2 2AT -5.5 -5.7 DE -0.3 6.4NL -4.6 -7.9 NL 4.6 0.9BE -1.3 6.6 BE 8.3 7.1FI 0.4 1.2 FI 11.9 1.1ES 4.8 9.7 Total 15.9 18.7IE 7.2 10.7 IE 17.2 24.8Total 7.3 10.2 ES 20.4 21.4FR 10.5 8.5 PT 21.6 36.4IT 18.6 24.6 FR 23.4 17.7PT 22.7 17.9 IT 24.8 36.1GR 57.6 26.5 GR 61.2 27.2

Sources of weak demand: investment demand is low, but is offset by above-average demand for

working capital. Unknown: how much smaller are lending volumes for Working Capital?

Panel (a): Ireland has the lowest share of firms whose need for external finance increased due to investment needs.

Panel (b): Ireland’s share of firms increasing their need for external finance due to working capital needs is above average

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Pattern reflected in Red C survey Mar-Sept 2012.“Reasons for making financial request”

A balance-sheet explanation for decreased lending: Negative relationship between new lending and 90-day arrears rate in a sector (Source Central Bank of Ireland lending data).

Expected bank rejections – Across euro area, the risk-adjusted coefficient on bank rejection responds to the macro economy…

Stronger Domestic Demand Lower Pr(Rejection)

More indebted private sector Higher Pr(Rejection)

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Bank Rejection

Competition among banks is decreasing since 2010 – potentially negative implications for price and access to credit for SME

Credit Rejection (% of applicants) – Mazars/Red C reports improving rejection rates. Still unfavourable in terms of European ranking.

Data: SAFE survey, up to

Wave 7 (Sept 2012)

Changes in Other Terms and Conditions – Ireland and other peripheral countries

still have most unfavourable patterns.

Summary• The Irish economy is experiencing the aftermath of a credit-induced property boom.

– Banks suffering losses and need to shrink balance sheets. Bank competition decreasing.– Firms over-leveraged; aggregate demand weak; zero fiscal space.

• The credit market is exhibiting the symptoms of this stress: – Sectors with higher loan arrears are receiving less new lending. – Countries in Europe with weaker demand or higher leverage have higher probability that

SMEs are rejected for credit.– The demand for financing does not appear below-average in Ireland. Demand for

investment financing is certainly weak in Ireland. Still not enough information on volumes.– There is evidence that Irish SMEs are experiencing credit constraints, beyond that predicted

by the weak economy here, in 2011-12 • Positives:

– Credit constraints appear to have reached their most severe in 2011. – Property prices, GDP and GNP stabilising– Govt. measures; NPRF €850M investment – fill funding gaps for firms, free up bank capital.

References to sources for this talk.

• Central Bank of Ireland. Economic Letter - Vol 2012, No. 8Irish SME credit supply and demand: comparisons across surveys and countries - Sarah Holton and Fergal McCann

• Central Bank of Ireland. Economic Letter - Vol 2012, No. 4Bank competition through the credit cycle: implications for SME financing - Fergal McCann and Tara McIndoe-Calder

• Central Bank of Ireland. Research Technical Paper 04RT12Firm Credit in Europe: A Tale of Three Crises by Sarah Holton, Martina Lawless and Fergal McCann.

• Bank balance sheet repair and credit provision: Insights from the Irish bank deleveraging experience. Jane Kelly, Reamonn Lydon, Martin O'Brien, Fergal McCann. Mimeo, Central Bank of Ireland.

• Credit Access for Small and Medium Firms: Survey Evidence for Ireland by Martina Lawless and Fergal McCann. Forthcoming Journal of SSISI

Thank you