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Europe’s SME crisis: Why Draghi’s plans may not work

Politicians and many economists across Europe are convinced that a healthy small business sector is crucial to the region's economic recovery. Yet funding seems to have bottlenecked.

The U.K., which was famously described by author W.M. Thackeray as a "nation of shopkeepers" in his Victorian novel Vanity Fair, is a prime example.

That Victorian spirit of enterprise is not being nurtured by some of today's banks, according to an increasingly vocal number of small businesses complaining of lenders not being willing to invest -- or rushing to sending in receivers.


"If you listen to the Prime Minister, or the Chancellor, or the Chief Secretary to the Treasury, they say the one thing that will bring back the economic recovery more quickly is if banks lend to SMEs – and they're not," Ronel Lehmann, chief executive, Lehmann Communications, told the U.K.'s Treasury Select Committee earlier in May.

Lending to UK businesses plunged in the first three months of 2014, despite a much-trumpeted Funding for Lending scheme to encourage banks to lend to small businesses, according to official data.

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Now European Central Bank President Mario Draghi is considering plans for a new model of financing aimed at making it easier for small businesses to access funding from "non-bank financial institutions" (ie the shadow banking system) which could include pension funds and insurers.

The ECB and Bank of England published a discussion paper on the securitization market on Friday, which has been seen by some in the market as a way of boosting appetite for asset-backed securities (ABS) – products whose values are derived from a pool of underlying assets – particularly for packaging up small business loans into ABS and making it easier for non-bank financial institutions to invest in them.

"A bank doesn't want to be sitting on illiquid assets for a long time, but shadow banks have a higher capacity to take illiquid assets and sit on them for a very long time," Alan Capper, credit strategist at Lloyds, told CNBC.

The idea is that risk is transferred from banks' balance sheets, which would make it easier for them to comply with more stringent capital requirements. And the first customer for these new securities would probably be the ECB. Around €15 billion of SME ABS purchases could be done over a year, according to JPMorgan estimates.

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These could potentially help banks"deleverage faster and stimulate new lending" and also "lay the foundations for a bigger securitization market in the long run," Kian Abouhossein, a banking analyst for JPMorgan, said.

Lori Greig | Moment | Getty Images

However, criticism of the plans is building before they have even been announced.

First, there is the danger that these products may echo some of the complicated financial engineering which helped contribute to the 2008 credit crisis. One banker, who did not want to be named, described them as "CDOs by another name," (referring to the collateralized debt obligations which are credited with the sub-prime mortgage crisis).

There is also the disparity between what a "shadow banking" pension fund wants – usually 10-30 year assets – and the typical five-year length of a small business loan.

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"The kernel of the problem remains that SMEs have demand for short-dated loans, and shadow banking wants long-maturity assets, which are easier to research," Capper pointed out.

"How do you create a quality tranche of loans banks are happy to keep which also keeps regulators happy?"

A further problem is that SMEs across the euro zone don't have the same problem: German small businesses are reporting that getting loans is increasingly easy, according to the Ifo institute. Underwriting standards and legal hurdles also vary.

Also, the funds which might want to hold these assets differ across the region. The UK system is based around household wealth and pension schemes, which might be more receptive to this type of investment, whereas in France and Germany life insurers are more likely to be interested.

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There is a lack of clarity over how such tranches would fare under new bank capital rules, which set out how much capital banks and insurers should hold.

Also producing a new financial product risks ignoring some of the other problems limiting small business lending.

The reduction of the number of high street bank branches, and subsequently the number of local bank managers who know businesses well has also been blamed for the poor lending environment.

Businesses are also less likely to approach banks for funding because of nervousness about getting into greater debt. Peer-to-peer lending has been mooted as an alternative, but has so far not provided the volume of funding needed.

The real answer may lie in reverting to the old-fashioned way of doing business -- rather than developing a new class of securities.

"It worked fine when you had experienced managers in banks who knew how to assess and advise. Now, there's no proper relationship," Peter Hollis, founder, Hollis and Co and a campaigner on small business loans, said.