In the column A phone call with... we talk to an expert about a current event related to economics, (responsible) investment, retirement and income. This time Charles Kalshoven (macroeconomist and expert strategist at APG) about the development that entrepreneurs and wealthy individuals are increasingly taking the place of banks when it comes to financing SMEs.
The role of banks in providing loans to small businesses is declining, writes Het Financieele Dagblad. The total number of non-bank loans rose to 5.1 billion in 2023; that is an increase of 27%. Figures from Stichting MKB Financiering also show that 36 percent of financing under 1 million euros to SMEs is currently happening outside banks. What does this mean for individuals that are investing, for SMEs and for the economy?
Risks
The fact that the number of banks loans to SMEs is declining is partly due to tighter regulations for banks. For example, they have to deal with higher capital requirements and are spending a lot of money on the many employees working on compliance and checking for possible money laundering or terrorist financing. This makes bank services more expensive, especially since Dutch regulations in this area often exceed those of other European ones. And then there is also a bank tax.”
With economic growth comes business, and with business comes risk, Kalshoven argues. “You can never eliminate them completely. Through stricter regulation you can reduce the risks at banks, but those risks quickly reappear elsewhere, for example with other parties ready to fill the vacuum left by banks. An advantage for private lenders is that they are not affected by strict banking regulations and supervision. Thus, they can benefit from “regulatory arbitrage.” What part of the advance of private credit this explains is difficult to say. Some of it can be explained by innovation. Fintechs do not drag the burden of old banking systems around with them and may be able to use smart algorithms to quickly assess whether a party can meet its payment obligations. If this allows them to make loans smarter, faster and more flexible than banks, that should be welcomed. That is the kind of competition that makes everyone sharper.”
Faster and more flexible
What makes it interesting for private investors to lend money to entrepreneurs is the fact that they get a higher interest rate than if they put their money in the bank, Kalshoven continues. “For SMEs, who see banks scaling back lending to small businesses, it represents a welcome new access to loans. Access that is also often more flexible and faster than a bank. Another advantage: sometimes private lenders have specific knowledge and expertise and can help with advice on, for example, the entrepreneur’s growth plans. The economy as a whole benefits when there is growth through these types of initiatives that otherwise would not have come about.”
Buffer
There are also drawbacks to this development, the macroeconomist tells us. “There are risks both for the lending individual and for the entrepreneur receiving the loan. Do they have enough information? After all, it’s not that banks have no function. They have risk models that allow them to accurately estimate the probability of a loan not being repaid, and how different risks are related.”
“Risk in itself is not a bad thing, of course, as long as it is appropriately compensated. For example, if a loan has no collateral, that comes with a higher interest rate. You can’t compare that to the interest rate on a safe savings account. Private lenders will therefore have to deliberately balance risk and return, which is fundamental to investing. What comes into play with the platforms that are intermediaries in this is that the interest rate the investor gets is not the same as what the SME entrepreneur pays. It is not that the difference is pure profit for the platform. A buffer is also created to absorb losses due to bankruptcies. A relevant question is whether that buffer is big enough. If not, in case of strong headwinds you can say goodbye to the promised interest and possibly also for part of your contribution. In short, the interest rates advertised are the maximum: it won't be more, and it might be less.”
There are also disadvantages for SMEs using private loans. “First of all, it is often more expensive than a loan from a bank. In addition, there is the risk of over-crediting: aren’t they loading too much debt on themselves? With a bank, this is subject to strict scrutiny, and the question is whether this is also the case with these types of platforms and intermediaries.”
SME bank
Last April, Minister Adriaansens of Economic Affairs and Climate came up with a plan of a kind of SME bank, which interest group MKB-Nederland is also keen on. The bank should be a public-private partnership, at arm’s length from the government, and should provide bank loans on favorable terms for smaller entrepreneurs. Kalshoven thinks this could be a good way to do it. “Promoting access to credit for companies that want to grow is obviously to be welcomed. It can be done on various levels. Sometimes just guiding entrepreneurs through all the financial information better can be of some help, but other ways are, for example, government guarantees or reducing the regulatory burden on banks. I’m not sure if there should be a separate entity for this. An advantage of banks is precisely that they provide both mortgages and business loans, financed in part by savings. Because of that diversification, banks are less affected by economic fluctuations. A specific SME bank would not have that advantage. And it will also have to finance itself with something other than savings. In any case, we see that non-bank loans to SMEs are already meeting some of the need, with all the advantages and disadvantages that come with it.”