Abstract
This paper focuses on the impact of financial fragmentation on small and medium enterprises’ (SMEs) access to finance. We combine country-level data on financial fragmentation and the ECB’s SAFE (Survey on the Access to Finance of Enterprises) data for 12 European Union (EU) countries over 2009–2016. Our findings indicate that an increase in financial fragmentation not only raises the probability of all firms to be rationed but also to be charged higher loan rates; in addition, it increases the likelihood of borrower discouragement and it impairs firms’ perceptions of the future availability of bank funds. Less creditworthy firms are even more likely to become credit rationed, suggesting a flight to quality effect in lending. However, our study also documents a potential adverse effect of increasing bank market power resulting from greater integration. This suggests that financial integration could impair firms’ financing, if not accompanied by policy initiatives aimed at maintaining an optimal level of competition in the banking sector.
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Notes
EU-28 includes all European Union member states at the time of writing (2019). In this paper, we refer to an SME by the standard European Commission definition (http://ec.europa.eu/growth/smes/business-friendly-environment/sme-definition_en). Data are drawn from the European Commission (2017) Annual Report on European SMEs 2016/2017.
Credit register data contains only information on loan applications. However, applicant firms are a sub-sample of all firms: some firms do not apply because they do not need credit, while others do not apply because of fear of possible rejection. As suggested by Popov and Udell (2012), Ferrando et al. (2015, 2017) and Freel et al. (2012), among others, not accounting for these informal credit constraints could bias the results of the analysis.
The capital markets union aims to provide new sources of funding for businesses, especially for small and medium-sized enterprises; reduce the cost of raising capital; increase options for savers across the EU; facilitate cross-border investing and attract more foreign investment into the EU; support long-term projects; and make the EU financial system more stable, resilient and competitive (European Council https://www.consilium.europa.eu/en/policies/capital-markets-union/). See also Zachariadis (2019).
According to Stiglitz and Weiss (1981), banks’ best strategy is to ration credit whenever demand increase interest rates above the optimal level.
There are many definitions of fragmentation in the literature; however, the term is typically used to refer to some forms of imperfect financial markets integration based on the idea that in the absence of fragmentation, the ‘law of one price’ should hold. Earlier studies that document that financial integration was achieved in the euro area (see for example: Baele et al. 2004; Rughoo and Sarantis 2012) used measures of integration; however, recent studies document a fragmentation pattern after the eruption of the global and the sovereign debt crisis (Horvarth et al. 2018; Mayordomo et al. 2015; Zaghini 2016) and started to implement new measures of fragmentation—i.e. for example dispersion across interest rates.
Other studies use (i) convergence of loans and deposit rates (Baele et al. 2004; Rughoo and Sarantis 2012) and (ii) the extent of cross-border activities, in terms of retail operations (Gual 2004; Perez et al. 2005), deals and foreign loans (Schnabel and Seckinger 2015; Emter et al. 2018). Both measures have drawbacks because interest rates could be different across countries due to differences in both banking products and characteristics of domestic borrowers. Equally, relying on cross-border activities ignores the fact that banks reduce lending operations less if, for example, the market is near; if they were present with a subsidiary, and/or if they acted in cooperation with a domestic lender (De Haas and Van Horen 2013; Popov and Van Horen 2015).
Unfortunately, data on new business loans is missing for some countries (for example Belgium and UK).
We do not distinguish between interest rates on small/large volumes (below/above EUR 1 million) of loans because the data is missing for Belgian, Greek and Portuguese rates both at the ECB and at the national central banks.
Ritz and Walther (2015) do not analyse empirically the effect of the wholesale funding shocks after the sovereign debt crisis. They develop a theoretical model to explain the effect of wholesale uncertainty on lending.
These results are not reported for the sake of brevity, but they are available with the authors upon request.
In addition, the questionnaire provides weights to restore the proportions of the economic weight (in terms of number of employees) of each size class, economic activity and country. All regressions use these weights.
See https://www.ecb.europa.eu/stats/pdf/surveys/sme/methodological_information_survey_and_user_guide.pdf for methodological information about the SAFE survey.
The abbreviation NACE is the classification of economic activities in the European Union (EU); the term NACE is derived from the French Nomenclature statistique des activités économiques dans la Communauté européenne.
Firms in agriculture, public administration and financial services are excluded from the questionnaire.
Simple fixed effects—i.e. country, time and industry—do not allow us to carefully separate common demand side shocks. For that reason, we use the interaction between fixed effects—i.e. country-time, industry-time and country-industry fixed effects.
This assertion is partially proven with the result in column 3 of Table 5, where we observe that financial fragmentation increases the number of firms that refused a loan due to the higher interest rates.
In a not displayed test (for reasons of brevity), we also control our results using alternative measures of financial fragmentation.
Firms that do not apply because of fear of rejection are included in the output equation of the Heckman correction procedure.
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Calabrese, R., Girardone, C. & Sclip, A. Financial fragmentation and SMEs’ access to finance. Small Bus Econ 57, 2041–2065 (2021). https://doi.org/10.1007/s11187-020-00393-1
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DOI: https://doi.org/10.1007/s11187-020-00393-1