The Need for Innovative Finance in the EU
Webster’s dictionary defines diversification as the act of introducing variety. Europe’s lending scene for small and medium-sized enterprises is anything but diversified, with transactions concentrated among the largest financial institutions headquartered on the continent. In fact, Europe’s SMEs receive more than 75 percent of their external financing needs from bank loans, which together with bank overdrafts or credit lines are the debt instruments used most often for fixed investment and/or working capital. In the U.S., by comparison, bank financing accounts for roughly 30 percent of corporate debt, and SMEs are able to attract five times as much funding from non-banks.
EU SMEs’ reliance on external financing from banks puts them, and the economic growth of Europe, at risk if banks curtail lending during an economic contraction. This risk became evident after the global financial crisis and amid the economic crises in the EU that have resulted in prolonged economic weakness and an unemployment rate hovering around 10 percent.
The crises, in addition to mounting regulation, have forced European banks to deleverage, which has worsened the financing environment for European SMEs. More than half (57 percent) of EU-28 SMEs prefer to acquire financing under $285,000 — which large financial institutions have typically shied away from providing. While expectations among EU SMEs are generally positive regarding the future availability of external financing, roughly one-quarter of SMEs did not feel confident enough to speak with banks concerning financing opportunities and nearly 15 percent reported that access to finance was their most pressing problem. The problem becomes even more acute with younger and smaller firms that experience higher rejection rates from banks.
This, of course, offers an opportunity for innovative forms of finance, such as crowdfunding and peer-to-peer lending, to provide alternative forms of credit to those businesses, particularly young and small firms, for whom access to external financing is most difficult. The alternative finance market in Europe is small but growing exponentially, up 144 percent in 2014 to roughly $3.4 billion. The sector is on track to reach about $8 billion by the end of this year.
We believe it is in the EU’s interest that these forms of funding continue to proliferate, and efforts to promote innovative finance solutions in the SME space should be commended. We have written before about the efforts made by the UK government, in particular, to facilitate capital formation and develop the financial technology sector.
We have also seen mainland Europe become more involved in supporting SMEs, with the European Commission recently presenting an action plan toward the formation of a Capital Markets Union. In particular, the Commission is interested in revising the EU financial regulatory framework by getting rid of outdated rules due to technological advancement and encouraging the development of innovative online platforms.
To be fair, these innovative forms of finance have a long way to go. They represent only a small fraction of the EU lending space and need to raise their public profiles. Their growth trajectory is promising, however, and these platforms are sure to play larger roles over time in the European alternative finance marketplace.
Source: EY, University of Cambridge, “Moving Mainstream” (February 2015)
The Milken Institute looks forward to hearing from our London Summit panelists representing Seedrs, Funding Circle, OnDeck, and E2Exchange on their involvement in and assessment of the alternative finance market for SMEs.