| Workshop 3: "Are small business loans another form of social lending" abstract by Albrecht Mulfinger |
(Albrecht Mulfinger is Head of Unit “Crafts, Small enterprises, Cooperatives and Mutuals” at the Directorate-General Enterprise and Industry of the European Commission)
BACKGROUND:
There are some 23 million enterprises in Europe, of which 92% are micro businesses with less than 10 employees. Almost half of those businesses consist solely of a self-employed and independent worker with no employees and no intention of recruiting any, due to financial constraints or fear of bureaucracy.
According to surveys more than half of all businesses are created with an initial outlay of less than € 5000, in particular in the services sector.
There is a general consensus that micro loans are those of less than €25 000, although micro enterprises may request much higher loans for investment purposes if they have growth projects.
Small business loans (including overdrafts) from the banking sector are sought after, as are other sources of external finance such as personal credit cards (with high interest rates of 19% or more), leasing (cars, office equipment ), 3 F money (Family, Friends, Fools) and consumer loans for dual use products, as some 60% of small businesses are partnerships.
The large majority of small businesses need small business loans at the point of their creation, and later for the replacement of used products or the renovation of business premises, and to comply with liquidity constraints due to late payment by some clients or tax claims. They have a stable relationship with their bank, and banks price the risk such that on average small business loans are profitable for the banks.
However, because of high administrative unit costs, a low profit margin, limited or no collateral and the higher failure risks of small businesses, banks from EU -15 Member States are sometimes reluctant to offer micro loans. Compared to consumer credits, small business loans are not standardized and present a higher cost for banks. In particular, commercial banks have largely withdrawn from this market.
They consider that loans to risky small businesses should fall under the responsibility of micro credit associations, in particular in the case of those business creators or entrepreneurs that are not bankable.
The emergence of social lending in some Member States is a response to the unwillingness of some banks to deal with those businessmen/women that come from an ethnic minority, have no school diploma, have insufficient business experience, are unemployed, have previous convictions or do not have sufficient resources of their own. The creation of their own business is often their only chance of becoming integrated into society and escaping poverty. A considerable number are women, often divorced and/or with children.
The search for shareholder value increases the number of excluded small business clients. As a result of their business practice, some banks count on the solidarity of society. Sometimes they support the emergence of not-for-profit organisations, and lobby their government to offer annual subsidies at national or European level.
Not all banks apply this business policy. Saving banks and cooperative banks less committed to the shareholder value principle still continue to offer loans to small and new businesses even with limited collateral. Often they cooperate with mutual guarantee societies that take over part of the risk, or the European Investment Fund on behalf of DG Enterprises and Industry of the Commission for additional guarantees in the case of non reimbursement of the loan.
By having a broad credit portfolio, banks manage to balance their risks effectively. As compared with micro finance institutions, which must handle a cluster risk, banks are in a better position to manage the special risks presented by small businesses.
The importance of micro finance institutions is uncontested. Such institutions need the support of volunteers for the provision of mentoring services and the support of citizens in the provision of additional finance, for example by donating interest and dividends from their account to micro finance institutions or even by sharing the burden of the risk of micro loans to businesses.
The situation in the new EU - 8 Member States is slightly different, as business creators and micro businesses have not been a priority for banks, especially in the regions, as the macro-economic supply of bank loans is not meeting the demand. Large companies, subcontractors for exporters and local authorities receive the best service to the disadvantage of SMEs in general and micro enterprises in particular.
Micro finance institutions meet an increasing market demand which is no longer satisfied by banks. The social economy sector plays a growing role in this finance segment to micro businesses that facilitate the finance of new business start-ups, and existing small businesses. It offers business support services such as assessment of business plans, mentoring services up to 2 years after the creation of the business or transfer to a new owner from high-risk communities.
In particular the high birth rates of ethnic minorities up to the 3rd generation and the high number of school leavers who do not have a diploma will induce a rising demand for micro loans. Businesses set up by citizens from ethnic minority backgrounds improve the social climate in deprived urban areas. Later they tend to offer a job to their children if their children do not find other employment.
Both small business loans and social loans have to be reimbursed. Differences between the two might arise in the price of the loan and the reimbursement period. Some micro finance institutions offer social loans for free in order to improve the survival rate in the start-up period. Others allow customers to delay the first instalment of the loan by 12 or 24 months. Even reduced interest rates could be justified. However, interest-free loans send new entrepreneurs the message that there is a free meal, and such loans support the emergence of a subsidy mentality.
CONCLUSIONS:
The importance of social lending has come about due to the unwillingness of some banks to deal with poorer and risky business clients. In the 19th century, credit unions or the Raiffeisenbank offered micro loans to their members with reasonable conditions, thus enabling their members to pay off excessive debt.
The forthcoming 2007 Basel II legislation, which obliges banks to price loans according to the risk involved, could even lead to more frequent rejection of socially weak small business clients who seek loans. More evidence is needed on this issue.
This is a chance for social financial institutions to develop their business activity. They often need public support because of the cluster risk and the support services offered.
There is considerable evidence that the survival rate of business creators by necessity supported by micro finance institutions and which offer mentoring services is the same as for those who create businesses by vocation. However the former rarely create any additional jobs, and those created in the ethnic minority community rarely have any social security.
Therefore, public support of micro loans for business creators and existing businesses by vocation or necessity should be balanced. There are economic arguments in favour of the support of small business bank loans because of the jobs created by growing and profitable businesses. There are social arguments in favour of social lending, since public support for business start-ups may reduce the overall social cost for unemployed citizens.
However it should always be borne in mind that the emergence of the microfinance sector and of social lending is a direct consequence of the failure of some banks in several Member States to do business with high-risk small business creators or entrepreneurs. |
| ID: |
37220 |
| Author(s): |
iff |
| Publication date: |
28/04/06 |
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Created: 13/04/06. Last changed: 13/04/06.
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