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  The business sector, for either SMEs or large firms, is crucial for economic growth. After all, a country's capacity to generate wealth and employment depends on business being healthy. Throughout the last few years this sector has been sunk in a deep recession in most developed countries, but the crisis has had a significantly more virulent effect on SMEs than their larger peers. Taking the Spanish case as an example, between 2007 and 2009 the number of SMEs fell 10.1%, much further than the 3.4% recorded for large firms. This greater vulnerability has reopened the debate about the weaknesses of SMEs and most particularly their financing difficulties.

  Although the definition of an SME covers a highly heterogeneous group of firms, making any attempt at generalization much more difficult, they do share certain traits that set them apart from large firms and affect their ability to secure external funding. Their smaller size and the higher cost of professionalizing their financial management limit their access to the capital markets (by issuing corporate debt or through the stock market). This makes bank loans the primary source of financing for SMEs.

  Moreover, there are two aspects that affect SMEs significantly in terms of financing: higher risk assessment costs and a higher probability of default. With regard to the first aspect, since financial management is less sophisticated among SMEs and up-to-date financial information is less readily available, lenders are forced to incur additional costs to determine a firm's solvency. With regard to the second aspect, their size restricts their ability to diversify, both geographically and across sectors, leading to a higher concentration of risk. Because of this assessment-risk issue, financing conditions for SMEs are usually stricter than for larger firms, both in terms of interest rates and the guarantees required.(1)

  But small and medium-sized firms have encountered an important increase in their financing needs during the latest economic recession. Consequently, according to the European Central Bank (ECB), 19% of SMEs saw funding as their second biggest problem during the last six months of 2009.(2) A higher proportion than the one reported by larger firms.

  There are various reasons as to why it's more difficult for SMEs to secure financing. This can be partly explained by the different use of funding. In the case of SMEs, a high proportion of the funds secured are used to finance their working capital (for example, through lines of credit), increasing their vulnerability in times of less liquidity, as recently. Furthermore, the financial turmoil that started at the end of 2007 affected the banking sector's borrowing capacity. As a result, financial institutions were forced to toughen up their credit standards, particularly in 2008 according to the ECB.(3) Lastly, deteriorating economic conditions weakened the solvency of many firms, hence their capacity to borrow also worsened.

  (1) Beck, T. et al. (2008), «Bank Financing for SMEs around the World: Drivers, Obstacles, Business Models and Lending Practices», World Bank Policy Research Working Paper. (2) Survey on the access to finance of small and medium-sized enterprises in the Euro Area. (3) The Euro Area Bank Lending Survey.

  All these factors worsened the situation for SMEs even more. In addition lower optimism regarding their future growth made it more difficult for them to access credit, and vice versa. The above graph, for example, shows that, in those countries where the business prospects for SMEs deteriorated more sharply (Spain, Hungary, Ireland and Iceland), financing difficulties were greater.

  It's no surprise that, given this scenario, most governments have implemented measures to improve financing conditions for SMEs. Among the most frequently used are direct lines of credit to finance exports or innovation projects, bank credit guarantees given to firms and improvements in SMEs' liquidity (reducing taxes and shortening payment delays for public procurement). This stimulated credit to small and medium-sized firms to a certain extent, although it wasn't enough to completely open up the traditional financing markets.

  However, in the same way that the deterioration in economic outlook worsened the situation in the sector, the current economic turnaround may be salutary. In this respect, the strong growth being recorded in the euro area, Spain's main trading partner, and particularly the recovery of the Spanish economy per se will come as a breath of fresh air for SMEs. In fact, some available indicators regarding the operations of small and medium-sized firms in Spain have already started to show a change in trend. Thus, in the first half of 2010, there was a net increase in the number of SMEs after two and a half years of continual falls. At the same time, figures from the Central Balance Sheet Data Office, published by the Bank of Spain, show a slight improvement in operating margins for medium-sized firms during the first quarter of 2010.

  In spite of small and medium-sized firms having embarked upon the road to recovery, in March this year 85.3% were still encountering difficulties in securing financing.(4) Without a shadow of a doubt, it won't be at all easy for financial conditions to get back to normal. The likely tightening up of banking regulations, for example, might slow up this process. However, the Spanish economy's gradual return to growth allows some room for optimism.

  (4) According to the survey by the High Council of the Chambers of Commerce.

  This box was prepared by Joan Daniel Pina

  Research Department, "la Caixa"

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