This paper is an update to ACCA’s early 2014 review of SMEs’ access to finance in Cyprus. It presents new analytical and theoretical work performed by ACCA in the meantime, and proposes possible avenues for further research.
Access to finance remained a first-order problem in the country in 2014, with almost 80% of ACCA reporting finance-related issues. This figure shows no signs of recovery as yet, and is over twice as high as the survey’s regional averages in Europe and the Middle East. Much of the country’s financing problem appears to be driven by cash flow conditions, including the legacy of capital controls.
On the face of it, late payments to businesses in Cyprus have fallen significantly in the post-bail-in period, with fewer than half of all respondents affected. It is almost certain, however, that this trend reflects the reduction in trade credit, as opposed to an improvement in credit conditions. If this interpretation is true, then it suggests that a substantial number of businesses in Cyprus have reverted to working mostly on a cash basis, post-bail-in.
ACCA’s first State of Business Finance review revealed that about 31% of ACCA members in Cyprus are regularly and actively involved in raising finance for businesses. While this percentage is in line with the global average, the review found a greater reliance on commercial mortgages and directors’ loans in Cyprus than in other major ACCA markets, in both cases as a direct effect of the state of the banking system. Also striking was the under-representation of asset-based finance and export/import finance in the mix of financing sought; the gap in asset-based finance supply in Cyprus was also highlighted in detail in Talos RTD’s report, Financing SMEs in Cyprus: No Stone Left Unturned?, published by ACCA in May 2014.
The latest round of EU-wide stress tests (results announced October 2014), combined with the Asset Quality Review (AQR) by the European Central Bank (ECB), have received widespread publicity for their implications on the capital adequacy of Cyrpus’ banks, and for their various methodological shortcomings. Overall, ACCA welcomed the results of the exercise as a great first step in ensuring comparability of asset quality and exposures, and predicted that investors and the public would find the outcomes reassuring. In Cyprus, the results were received with relief.
The stress test results reveal that, as of late 2013, SME loans made up just under 30% of the balance sheets of Cyprus’ banks. This equates to total outstanding loans of €14.9 billion, equivalent to 82.1% of GDP. By this measure, Cypriot banks are SME-heavy compared with their European counterparts, in line with the country’s greater reliance on SMEs for economic output and employment. Across the European banks covered by the latest stress-test, SME exposures made up only 11% of the total balance sheet.
Crucially, the Asset Quality Review found that half (50%) of the Cyprus-based banks’ total exposure to SMEs is in fact made up of non-performing loans – loans to SMEs are almost twice as likely as other balance sheet items to be non-performing. This is not a problem unique to Cyprus but, given the country’s much greater reliance on SMEs for output and employment, it is a major issue.
As a rule, SME exposures attract high risk weights owing to their higher probability of default, thus discouraging lending. SME loans in Cyprus account for 30% of the balance sheets of the country’s Big Three banks, but they account for 53% of their total defaulted assets and 45% of their risk-weighted assets. In other words, SMEs account for 45% of the capital requirements of Cyprus’ banking sector. In light of the above, the following initiatives could improve the capital-efficiency of SME lending, at least at the margins and over time.
1. A review of the capability of Cyprus’ banks to move to internal ratings-based risk weights could require public investment in a comprehensive credit risk model, hinted at in ACCA’s original review of SME lending in early 2014.
2. A long-term review of collections and forbearance practices and outcomes among the banks could be carried out with the ultimate goal of preparing robust evidence for internal ratings.
3. A review of the potential for re-classification of some SME exposures as retail exposures could focus particularly on small loans that are director-guaranteed.
4. A review of the potential for using alternative assets, especially registered Intellectual Property, as collateral for SME lending could be undertaken, modelled on systems of state guarantees provided against the value of intangible assets in other key ACCA members, such as Singapore and Malaysia.