Clear and objective communication with banks is essential for SMEs

With a pivotal role in economic and employment development, Small and Medium-sized Enterprises (SMEs) face difficulties in obtaining financing. SMEs are a reality in practically all economic activity sectors in Portugal.

‍

“In Portugal, small and medium-sized enterprises are neither listed nor have access to financial markets because, predominantly, a “bank-based system” is used, causing them, if they need it, to resort only to banks” for financing, concludes a study conducted for a master's thesis at the University of Minho, carried out in May 2018.

The research, authored by Tomás Sardinha, focuses on the difficulty of financing SMEs and seeks to understand how banking institutions differentiate financing conditions between large companies and SMEs. This investigation is based on data from the Bank of Portugal and the National Institute of Statistics (INE) and uses a macroeconomic approach as its methodology (where it analyzes the sector of activity, company size, and market interest rate).

The study reveals that, by definition, SMEs usually do not have sufficiently complete accounting organization prepared for the analytical detail that banking institutions apply, which may cause greater obstacles to the financing requested by small and medium-sized enterprises. “There are two types of information that companies can provide: information based on company records (balance sheets, credit history, among others); and another due to the deduction of gaps in accounting information and subject to many errors,” the dissertation states.

When a company does not provide sufficient information, it becomes “opaque” and reduces its ability to demonstrate the possible success of the project. Thus, granting credit to companies that present this lack of information becomes a risk for banking institutions, leading them to charge higher interest rates and demand more guarantees.

Another reason that, according to the dissertation, underlies the difficulties in financing SMEs is the fact that small banks finance them. In contrast, large banks tend to grant credit to large companies because they believe these obtain better results.

On the other hand, small banks will have more similarities with SMEs in terms of organization, which allows for easier approximation and, consequently, fewer reservations when granting credit.

The research also shows that “banks prefer to work with more mature companies that have some kind of relationship,” as some companies end up closing in their first year of existence. More mature companies reduce the risk of bankruptcy and become more credible, which conveys security to banks when it comes to financing.

There are strong reasons why it is difficult for new companies to obtain financing, because rather than checking whether it is a small, medium, or large company, banking institutions choose to analyze the companies' turnover. “Since they are new [companies], they do not have a credit history or activity history, which makes it more difficult for banks to analyze their projects to grant financing,” analyzes Tomás Sardinha.

The study results show that turnover influences by 15% - proportionally more relevant than the other variables - the decision to finance or not a company. When they do not meet the guarantees required by banking institutions, they end up not getting the financing.

On the other hand, the results also indicate that SMEs reject these guarantees. Alternatively, small and medium-sized enterprises seek other types of financing, the most common being self-financing - that is, a source of financing generated within the company itself, namely, items such as net income, depreciation, and provisions from the economic year after year -.

The dissertation concludes, then, that “for SMEs, whether newly established or not, it seems essential to communicate with banks objectively and clearly, so that financing can be carried out under the best conditions according to the type of company and the investment.” Turnover is also pointed out as the factor that dictates whether the company will be financed or not.

Dissertation published in May 2018, authored by Tomás Sardinha, as part of the Master's in Monetary, Banking and Financial Economics, at the University of Minho: http://repositorium.sdum.uminho.pt/handle/1822/55288

‍