European SMEs
Positive Economic Outlook, Greater Profitability, The Same Funding Gap.
European SMEs have achieved greater profitability than large companies, showing strong resilience and business acumen to weather the interest rate storm during previous years.
During the first three quarters of 2024, European SMEs have achieved greater profitability than large companies, showing strong resilience and business acumen to weather the interest rate storm during previous years. Moreover, there are positive economic expectations on the region, suggesting high-growth strategies are likely to be achieved. However, as an overall, European SME’s have not seen a significant reduction in funding costs or availability from traditional financial institutions compared to 2023, and the first half of 2024, resulting in higher appetite for alternative lenders offering working capital, trade finance and growth loans.
Introduction
European enterprises reported facing significant challenges in accessing finance for their operations and growth. Increased interest rates imposed by central banks to control inflation and bring it back to its 2% target created hurdles, particularly for Small and Medium Enterprises (SMEs), not only due to the increased cost of borrowing but also resulting from cautious banking practices. Both factors contributed to widening the financing gap between availability and need for funds.
Due to an improved economic environment with inflation close to its target, central banks have started cutting interest rates. The main results of the Survey on the Access to Finance of Enterprises (SAFE), which asks firms about the economic and financing developments during each quarter of 2024, show an improvement in economic terms for enterprises in the second and third quarter compared to the first quarter of 2024. However, despite interest rate cuts, banks remain conservative, limiting the availability of financing, especially in weaker economies across Europe.
We expect SMEs in Europe to continue facing a higher funding gap from traditional financial institutions, fostering a genuine interest in fulfilling their financing needs with alternative lenders such as private debt funds that offer a tailored approach towards credit agreements, adapting and complementing growth strategies while paying similar fees than with traditional financial institutions. Moreover, we expect such companies to be curious about accessing capital markets instruments such as equity listings and bond listings due to accelerated growth potential.
Financing Cost Disparities Between SMEs and Large Enterprises
Financing cost disparities between SMEs and large enterprises historically tend to increase in periods of increasing interest rates and decrease as interest rates fall. This trend remains true as the European Central Bank (ECB) raised interest rates to alleviate inflation levels across Europe, which led to an increase in financing cost disparity between larger enterprises and SMEs. This disparity arises from banks’ perception that SMEs represent a higher credit risk due to limited credit history and smaller collateral bases.
Graph 1: Change in Price Terms and Conditions as Perceived by Euro Area Firms
Graph 1 looks at historical changes in price terms and conditions as perceived by the euro area as a weighted average score in percentages as reported over the years by enterprises in the SAFE report. Using historical data from 2011 up until 2024 Q2, the graph projects a forecast of how this change in price terms between large firms and SMEs will look from Q3 of 2024 to Q2 of 2025. The financial cost disparity gap is forecasted to decrease at a slow pace, hovering over the 10-20% range. Such a gap gives testament to how, despite the improved economic conditions, it will start to close down, and a significant difference between the financing costs for SMEs and large enterprises will remain in the next 4 quarters.
While in countries with a healthy economy, higher borrowing costs can constrain SMEs' capacity to invest in growth and development, in countries with weaker economies where SMEs rely on financing to run their day-to-day operations, higher costs can lead to insolvency. In the EU, around 99.8% of companies are SMEs, which, according to the EU, is any company with fewer than 250 employees, and these SMEs generate around 58% of the EU GDP.
High costs of borrowing and limited financing availability can severely hamper the economy. A loophole where limited access and high costs constrain the ability of SMEs to perform, grow and potentially survive could slow down economic growth and lead to a worsening in the economic environment. This would subsequently further fuel the bank’s worries and perception of risk associated with SMEs due to their increased vulnerability, leading to a further decrease in the availability of finance.
Country-Level Gaps in Demand and Availability for Finance
Access to finance varies significantly between countries in the eurozone, driven by the banking sector condition and the overall health of the economies. Countries like Denmark, which has a robust economy and strong and supportive policies, benefit from higher financing availability and steady financing needs, which leads to a small financing gap. On the other hand, countries like Greece face a substantial financial gap between needs and availability, which, despite an improvement in the economic scenario, is still widening.
The SAFE survey data illustrates these differences between availability and needs for bank loans, looking at Q1 to Q3 of 202 in terms of net percentage and percentage of respondents. In addition, the survey also looks at the percentage increase or decrease in reported enterprise vulnerability.
The following bubble plot graphs visualise data from the 31st and 32nd SAFE surveys. With financing availability in the x-axis and financing needs in the y-axis, expressed as percentage figures of respondents, one can see the movement from Q1 to Q2 to Q3 (from a lighter tone to a darker tone of each country-specific colour). In addition, the size of the bubble represents the vulnerability reported by firms, providing an additional layer of data to further understand how the changing economic environment affects enterprises.
Graph 2: Bank Loans Availability vs Needs Across Europe
Graph 2: Bank Loans Availability vs Needs Across Europe depicts these differences in country-level financing gaps in Q3. Looking at various countries with different economic scenarios and clusters in the euro area, one can see how different companies have reacted and have reported their financing needs and availability in Q3 of 2024. The data suggests that although 66.6% of (8/12) countries reported an increased financing availability in Q3 of 2024, only 25% of (3/12) countries saw a significant increase of more than 5% in the availability of financing. On the other hand, 41.67% (5/12) of countries reported having an increase in financing needs.
Table 1: Bank Loans Availability vs Needs: Q1 2024 – Q3 2024
Table 1, which looks at Italy, Spain and Finland across the first three quarters of 2024. Italy and Spain have seen increases in availability of financing which is supported by the improvement in the macroeconomic environment with a close-to-target inflation rate and lower interest rates. Concerning, perceived financing needs, Spain and Italy saw a significant increase from Q1 to Q2. From Q2 to Q3, Spain managed to maintain the perceived availability of financing at the same level as a result of both an improved economic environment and a decrease in financing needs. From Q2 to Q3, Italy saw a further increase in needs, which consequently contributed to a decrease in perceived availability, which, despite this fall, remained higher than in Q1. Finland behaved quite differently as availability fell from Q1 to Q2 and then came back to its Q1 level in Q3. Needs, however, significantly increased from Q1 to Q2 and remained at the Q2 level in Q3. Concerning vulnerability, Italy saw the most significant decrease, with a 2% fall from Q1 to Q3. Spain’s vulnerability only decreased by 1% from Q1 to Q2 and remained constant at 5% from Q2 to Q3. Finland’s vulnerability, although decreasing 5% from Q1 to Q2, increased 5% back to its Q1 level in Q3.
Bank Lending Constraints Despite Interest Rate Cuts
Despite interest rate cuts by the ECB, banks have maintained restrictive lending policies, which particularly affect SMEs. There are several factors which contribute to this behaviour. Firstly, banks continue to be cautious in extending credit due to economic uncertainties, stricter regulations and the antecedent of the collapse of banks like the Silicon Valley Bank SBV. In addition, pressure to reduce risk exposure leads to stringent requirements that, for smaller businesses, are difficult and costly to meet. This restrictive lending is problematic, especially for SMEs, as it limits their financial flexibility.
Graph 3: Interest Rates – Q2 2022 to Q2 2025
Like the 31st, the 32nd round of the SAFE survey conducted between the 2nd of September and the 15th of October suggests that although borrowing costs continued to rise to a much lower extent than the second quarter, many firms still indicate a further tightening of other loan conditions. In addition, 20% of firms perceived the general economic outlook to be the main factor hampering the availability of external funding, which represents a steep rise from 12% in Q2.
Worryingly, despite inflation rates falling and continuing cuts across Q2 and Q3 in interest rate levels, only 6% of firms reported an improvement in banks’ willingness to level, which is lower than the 9% reported in Q2. In addition, firms reported a slight increase in perceived vulnerability in Q3, and fewer enterprises reported increased investments compared to Q2. Across size classes, large enterprises still signalled better overall financing price terms and conditions when compared to SMEs.
Although the financing gap for bank loans narrowed in Q3 compared to Q2, this was mainly due to a decrease in needs rather than an increase in availability. Only 1% of firms reported an improvement in the availability of bank loans, which is lower than the 2% reported in Q2.
APG expects European SMEs to face higher funding costs than its large peers.
Historical data shows that market traditional financial institutions have taken longer to transfer lower costs of funding to SMEs than they have done so for larger companies. This can be explained by the higher bargaining power expressed towards SMEs as historically, the way to serve such companies has been through standardised lending products, differing greatly from their approach towards larger companies, as larger companies have a wider pool of funding options to opt from, creating a balance of power between them and their traditional financial service providers. Additionally, the experience in financial and capital markets that large companies hold at their financial divisions has historically been more structured and experienced than SMEs can afford, creating a knowledge disparity between these entities that allows larger companies to strengthen their bargaining agreements when it comes to negotiating funding rates and fees.
As markets expect the central bank to continue lower rates, we expect that SMEs face a similar challenge than in the past, with a funding cost gap to sit between 10% and 12% in Q1 and Q2 of 2025, around 6% lower than in the previous interest rate falling cycle where it was between 14% and 17% in 2024. Having said this, we acknowledge that teams in the finance divisions of European SMEs today are more knowledgeable than in the past, making them hold a competitive advantage versus their funding counterparts, but also making them more inclined to choose alternative financing products and instruments in the private markets and capital markets.
Conclusion
In conclusion, despite an improvement in the economic scenario in the euro area with inflation levels close to their 2% target, lower interest rates, and a positive outlook, the availability of external funds in the form of bank loans has remained relatively low. Despite fewer firms reporting a rise in interest rates compared to Q2, stricter collateral requirements and a reported increase in other financing costs like fees, commissions, and charges have led to a continued rise in the cost of bank loans.
In the current economic scenario, as reported in Q3, the main reason why applications for bank loans remained low was due to SMEs facing significant improvement in liquidity ratios, and higher access to private lenders, as these companies have showed greater willingness to seek alternative funding sources.
APG’s expects European SMEs to enhance performance during 2025, facing greater working capital and capex funding requirements. Even though funding costs will likely to be lower, as financial institutions and private lenders face the need to become more competitive, SMEs would likely be inclined to seek alternative lending solutions to achieve tailored made solutions and greater expansion capacity.
Despite an improvement in the economic scenario in the euro area with inflation levels close to their 2% target, lower interest rates, and a positive outlook, the availability of external funds in the form of bank loans has remained relatively low,
References:
EPP Group in the European Parliament (no date) Helping small businesses to thrive. https://www.eppgroup.eu/what-we-stand-for/our-priorities/helping-small-business-to-thrive.
European Central Bank (2022) Monetary policy.
European Central Bank (2024a) Survey on the Access to Finance of Enterprises in the euro area - First quarter of 2024. https://www.ecb.europa.eu/stats/ecb_surveys/safe/html/ecb.safe202404~580876cfb9.en.html.
European Central Bank (2024b) Survey on the Access to Finance of Enterprises in the euro area - Second quarter of 2024. https://www.ecb.europa.eu/stats/ecb_surveys/safe/html/ecb.safe202407~58a9f48351.en.html.
European Central Bank (2024c) Survey on the Access to Finance of Enterprises in the euro area - Third quarter of 2024. https://www.ecb.europa.eu/stats/ecb_surveys/safe/html/ecb.safe202411~451cceb0f4.en.html#toc3.
World Economic Forum (2024) Businesses driving the EU economy. https://www.weforum.org/stories/2024/01/chart-drive-eu-economy-small-business-sme/#:~:text=Globally%2C%20SMEs%20make%20up%20about,for%20over%20100%20million%20jobs.
