Securitization: Restore Credit Flow to Revive Europe’s Small Businesses
IMF Blog, May 7, 2015
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- Authors: Shekhar Aiyar, Bergljot Barkbu, Andreas Andy Jobst
- Published: May 7, 2015
Role and importance of SMEs
- SMEs account for "99 out of every 100 businesses" in Europe.
- SMEs employ "two in every three employees".
- SMEs generate "58 cents of each euro of value added of the business sector in Europe".
- Improving access to finance for SMEs would support a broad-based recovery for Europe.
SME reliance on banks and crisis impact
- In 2014, "more than two-thirds of SMEs in Europe used bank financing".
- In 2014, "less than one fifth used non-bank financing sources, such as equity and debt securities".
- Heavy dependence on banks made SMEs vulnerable when the crisis led banks to raise interest rates and ration credit more tightly to SMEs than to larger firms.
Potential gains from securitization
- Quick and lasting gains:
- Securitization could help SMEs attract non-bank funding by enabling banks to sell securitized loans to investors.
- For banks, securitization would free up capital to support new lending.
- Long-term funding:
- SMEs will also need direct access to bond markets, private equity, and venture capital.
- Scale of opportunity:
- Combined stock of outstanding SME securitization in Germany, France, Italy and Spain was "€57 billion in mid-2014".
- Banks’ outstanding SME loans in those countries were "€849 billion".
- "Just above five percent of SME loans are currently securitized."
Risk record and standards for safe securitization
- Historical default performance for European securitization instruments has ranged between "0.6 to 1.5 percent".
- Default performance for securities backed by SME loans has been "0.1 percent".
- Policy objective: limit risks further by encouraging "simple, transparent, and prudently-structured securitization instruments".
- High-Quality Securitization (HQS) proposal:
- HQS instruments should meet strict rules on asset eligibility and quality.
- HQS instruments should be subject to rigorous disclosure and reporting requirements.
- SME securitization would include specific requirements to mitigate SME loan risks.
Policy actions to boost SME securitization
- Recognizing high quality:
- Regulators should treat transparent, prudently-structured HQS more leniently than opaque, complex forms.
- Regulators need to "settle on a uniform definition for HQS and then apply it consistently across all European Union financial regulations."
- Better infrastructure:
- Harmonize credit reporting.
- Take steps toward "a functional convergence of debt enforcement regimes across European Union countries."
- Expected effect: lower cost of securitizing SME loans and encourage cross-border investments.
- Targeted official support:
- Integrate existing initiatives (European Investment Fund’s standing facility for credit enhancements; the European Union SME Initiative; COSME; the European Fund for Strategic Investment) to boost catalytic role.
- European Investment Bank could act as a strategic investor to jumpstart the market.
- Recognition of HQS as collateral for Eurosystem liquidity operations could help develop a deep and liquid securitization market.
How SME securitization works (mechanics)
- Definition: pooling income-producing assets so they can be repackaged and sold to investors.
- Typical steps:
- Step 1: A bank pools SME loans into a "reference portfolio".
- Step 2: The bank sells the portfolio to an issuer, such as a special purpose vehicle, passing on most of the credit risk and freeing up capital for new lending.
- Step 3: The issuer finances the acquisition by selling tradable securities to capital market investors; investors receive interest payments funded by cash flows from the SME loans.
- Structural features:
- Portfolio assets are detached from the bank’s balance sheet (and its credit rating), allowing issuers to raise funds more cheaply.
- Slicing securities into "tranches" tailors risk-return properties to different investors and broadens the investor base.
Source: Shekhar Aiyar, Bergljot Barkbu, Andreas (Andy) Jobst — May 7, 2015 (IMF blog).
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