Opinions & Interviews

2021-11-17 Roberto Ruozi

Interesting Developments in the Relationship between Banks and SMEs

An analysis of what is happening in our country in recent years indicates that the relationship between SMEs and banks is changing. Banks seem to better understand the importance of loans, and more in general, of client relationships with SMEs. A consequence of this evolution has been the reorganization of the internal structures of banks, strengthening technology in client management, and the birth of new banks specialized in lending to SMEs.

An analysis of what is happening in our country in recent years indicates that the relationship between banks and SMEs is changing, even though the problem is not simple, and to understand it we must differentiate the two worlds. On the one hand, there are big banks (hereinafter BBs), local banks (hereinafter LBs), and new banks; on the other hand, there are SMEs operating in very different sectors, such as manufacturing, construction, ICT, professional services, and so on, but also with varying dimensions, as well as track records that can be more or less consolidated, or that remain to be invented, as in the case of startups.

Generalizations on this theme are thus increasingly unreliable, and to seriously discuss it we need to compare the various types of banks and SMEs, that is not possible here. So my analysis of the problem will only be a first approximation, seeking to identify the changes underway in the underlying trends.

The problem is particularly significant in Italy, where the incidence of SMEs on GDP and employment is very high, certainly higher than the European average. Their importance is also growing, and the availability of financial resources for their development is decisive, with bank lending even more important, given the absolute predominance of that channel for the funds that SMEs can obtain.

An analysis of what has happened in recent years shows three phases. The first, which lasted until about a decade ago, was fairly confused. In practice, there was no clear and different strategic approach on the part of the various categories of banks in regard to different types of businesses. There was a sort of full-scale competition, with branches as front-line competitors, along with their more or less specialized personnel who worked to establish stable relationships with clients essentially based on credit. It was evident, though, that even without precise formal strategies, BBs served large companies better, both due to their greater financial capacity and due to the greater ability to offer not just loans, but other more sophisticated services as well.

For their part, SMEs did not have much choice, and thus they preferred LBs which were closer to them physically and in their decisions could take into account elements that could only be considered based on personal acquaintance between bank official and entrepreneurs, reducing the times and risks of loans to a minimum. For banks the cost of managing these loans was not proportionate to the size of the loans themselves, given that the approval process was more or less the same for smaller loans requested by SMEs, and larger ones requested by larger companies. Experience also demonstrated that the risk of loans granted to SMEs is higher than those granted to large companies. When there began to be trouble for the financial accounts of banks, and of BBs in particular, they reduced their relationships with SMEs and concentrated on larger companies. The consequent phenomenon of rationing credit to SMEs, that lasted for years and in reality hasn't fully ended, came mainly from those types of banks, which, however, were unable to fully replace the reduction of loans to SMEs with the new ones granted to larger companies.

In this climate, a second phase emerged, that lasted until 2020, characterized by the definition of new credit strategies on the part of banks, including in formal terms. The attention and interest of BBs were deliberately concentrated on companies that were not small. To manage them, structures were created to be specifically dedicated to them, with both internal units and the establishment of specialized banks with a certain level of operational autonomy with respect to the parent company. The organization and functions of local bank branches were also changed, and in many cases caused the loss of local autonomy in granting loans not only to larger companies, an activity that was concentrated in the specialized units just cited, but also those to SMEs, that were falling, but still existed; this extended the times for acquisition, granting, management, and monitoring of the loans. The result was a reduction of the competitiveness of BBs in the SME loan market, and the strengthening of LBs, that exploited the situation to make use of their greater ability to establish stable client relationships with SMEs. Their actions were also favored by the mass branch closures implemented by BBs. For their part, the greater innovative capacity of BBs, including in terms of structures and technical forms of loans and other related services provided to larger companies, did not produce the desired results. The objectives of the internal departments dedicated to large companies and those of the new banks specialized in corporate lending were generally not reached, while their market share in regard to SMEs fell sharply

In this situation, the position of the LBs in regard to SMEs was strengthened, and those banks began to recognize that, in order to continue to prevail in this battle, it was necessary to change their approach to clients. In particular, while for a long time the banks in question had a more or less passive attitude in regard to most clients (although this was also true for the BBs in the markets they concentrated on), the decision was made to adopt more active behaviors in which it was no longer the client who sought out the bank, but the bank that sought out the client.

The shift was not easy, especially because it implied a cultural and professional change which the LBs were not culturally and professionally prepared to manage. They in any event reacted with determination, and their positions in the SME loan market continued to expand in absolute and relative terms.

Demand in this market was in fact growing, due to both the new financial needs of SMEs as a consequence of Covid-19 and preparations for the recovery, that finally seemed near, and because the demand for bank loans on their part was however expected to increase regardless of the contingent economic situation. A recent study by Exton Consulting, citing various British sources, reported that, if only due to the administrative difficulties and times necessary to obtain a bank loan, 50% of SMEs have submitted only a single request in their lifetime, and 29% have never even begun the process to request a loan due to the complexity in terms of time and effort requested by banks. The room to improve the positioning of LBs in regard to SMEs is thus very ample.

Some of the anti-Covid-19 measures had a similar effect, as they strongly supported the granting of bank loans to SMEs, while transferring the relative risk directly or indirectly to the state. Technology was also revolutionizing the lending sector of the BBs and LBs in more or less the same manner, enormously reducing the times and costs of the cited operations of acquisition, granting, management, and monitoring of loan positions and also reducing the margin of error and thus the risks of the related activities, requiring a considerable increase in the professional skills of the employees involved.

In this situation, the third phase began recently, that as a whole represents one of the most interesting aspects of the evolution of our entire banking system, which seems to have better understood the importance of loans, and more in general, of client relationships with SMEs.

This third phase, that is strongly taking hold now, seems to be characterized by three phenomena inevitably linked to each other:  a) the revival of interest by BBs in regard to SMEs, accompanied by organizational changes that have led to the establishment of offices or subsidiary banks specialized in that segment, with ample communication of the birth of the new banks in the press, television advertisements, and also long interviews with their top representatives; b) the strengthening and technical revolution of that management also in LBs, whose policies in regard to SMEs have become more aggressive and have also been favored by an intense use of technology which for them is even easier and less costly than for BBs, especially at a time when the traditional assessment of creditworthiness of clients has become more complex due to the confusion and difficulty of procuring the data on which it has long been based. At the same time, it is simpler, because once the algorithms for the assessment of the new elements taken into consideration, substituting the old elements, have been carefully studied and weighed, the process essentially becomes automated, obtaining results almost in real time and at almost no cost; and c) the birth of new banks specialized in lending to SMEs, which I have not mentioned to this point only because they represent a marginal share of the market, but which will need to be taken into consideration in the future, given their lively and rapid rate of growth.

It is too early to say whether these three factors will truly improve the situation of SMEs. We need to see in particular if the communications and interviews cited above for the BBs will turn out to be only messages that allow the banks to burnish their image in regard to entrepreneurs by presenting a new name, but an activity that is not substantially different from the previous business. In reality, given that the room for the increase and enhancement of that business is considerable, the new potential should become concrete, and should develop simultaneously with the upgrading of the sales structures of the LBs, that even if only to survive, must follow that path since they do not have any serious alternatives.

These new approaches to SMEs on the part of both BBs and LBs will also be supported by oversight authorities, that have de facto already forced all banks to adopt more rapid and efficient methods of acquisition, granting, management, and monitoring of loans to companies, and above all, to SMEs.

A problem remains, that of non-performing loans, that cannot be analyzed in depth here, even though it has been fundamental in the crisis and subsequent recovery of our banks. I believe, though, that prospectively, and also based on past experience, this problem is not due to the different strategies presented above, but above all to the quality of the approval processes, that as we have seen have been subject to radical changes in all types of banks. That quality, or better, the technical elements that determine it, in any event vary in the various combinations that have been repeatedly cited, but the risk of those loans does not depend so much on whether the banks and companies are large or small, but on the criteria they use to assess loans. In addition, there is also something imponderable that can never be eliminated, but this eludes the forecasts and supervision of lenders, and is part of the objective risks of their occupation.