28 TRANSITION REPORT 2015-16 REBALANCING FINANCE

SMALL BUSINESSES AND THE CREDIT CRUNCH

THE AVERAGE RATIO OF THE PERCENTAGE OF TOTAL BANK LOANS TO CREDIT-CONSTRAINED CUSTOMER DEPOSITS FIRMS RANGES FROM JUST DECLINED FROM 13% IN TURKEY TO 120 % 85% IN 2008 TO 97% IN 2013 IN EGYPT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 29

Credit conditions for small businesses have tightened significantly in recent years, both during and after the global financial crisis. Structural adjustments in banking systems – particularly reduced reliance on cross-border and wholesale funding – explain a large part of this tightening. The composition of local banking markets also plays a role since small businesses are more likely to borrow from banks that have less hierarchical lending procedures, a greater focus on building relationships with clients and more confidence in local courts. Access to credit may therefore benefit from both stronger legal enforcement and more effective and efficient bank lending techniques.

OF FIRMS REPORTING A NEED FOR CREDIT IN THE 2013-14 BEEPS SURVEY WERE UNABLE TO OBTAIN 51% IT – UP FROM 34% IN 2005 2 1 declines). such reflecting merely than (rather in output reductions in causing role do in –and many countries can factors side recovery. economic long-awaited the smothering is lend to banks of unwillingness or inability the that worry to need no is there demand, of a lack reflect indeed does in lending bank reduction the that extent the To credit. additional for apply to reason little is there less, invest and firms makes consume less households uncertainty economic all, when After region. in the observed currently growth lacklustre the reflects that phenomenon a demand-driven be predominantly may in lending bank reduction The not. Perhaps growth? credit GDP ratios. debt-to- aggregate in their increases –have seen paradoxically somewhat –perhaps that countries in some occurred even has this 1explained, Chapter 2.1). As Chart (see level lower afar at stabilised since has growth credit Nominal region. transition the of much across cent per 40 and 20 between of growth annual nominal credit with expansion, credit rapid of period long of a end the marked 2008-09 of crisis financial global The Introduction 30 countries. in many demand estimated total the of short fall to continues – equity and credit both – finance SME of supply the reasons, these allFor of firms. larger than experienced less therefore and younger be to Moreover, tend SMEs post. to collateral have less typically and lenders to transparent less be to tend firms Smaller credit-constrained. be to tendency have agreater economies, advanced and markets emerging most in firms of majority vast make which up the SMEs, aresult, As credit. bank access to afirm’s ability sizeits and between correlation positive astrong is there that suggests Evidence 250 people. than more no employ that as firms (SMEs), are defined which enterprises medium-sized number of recommendations. policy a with concludes chapter The credit. to access hinder or help can landscapes banking in local how variation see to region transition the across cities and towns individual at closely more looks then chapter the of half second The in lending. bank reduction the of drivers supply-side and demand-side between distinguishes explicitly This analysis crisis. financial global the of start the since years seven the in credit-constrained more become have firms whether gauges it bank-leveldata, and firm-level macroeconomic, of Using a combination region. transition of the lens the through credit. on byasqueeze affected disproportionately be to out turn borrowers certain if particularly lending, bank reduced about worry to are right policy-makers case, the is that If countries. many of performance growth underwhelming the for blame to

See Lopez de Silanes et al. (2015). (2015). al. et Silanes de Lopez See dissenting voice. voice. a dissenting (2013) provide Stulz and (2014). Kahle Chodorow-Reich (2010) and al. et Duchin instance, for See, However, the emerging academic consensus is that supply- that is consensus However, academic emerging the in contraction sharp this about worry policy-makers Should Throughout this chapter, the focus is on credit to small and and small to credit on is chapter, this focus the Throughout debate this Transition the of revisits Report chapter This 2 1 In other words, credit shortages may be partly partly may be shortages credit words, In other – play a decisive adecisive –play FINANCE REBALANCING 2015-16 TRANSITION REPORT

interviewed firms that needed additional bank credit declined declined bank credit additional that needed firms interviewed of percentage The 10 years. last over the SMEs among lending. new of supply the fall in or a credit for demand reduced mainlyreflects time in point aparticular at country in in agiven lending a decline whether into insights useful yield can questions these to rejected when they do. they when rejected are or loan abank for applying from discouraged are either but of that are in need credit, (additional) those firms are constrained Credit- that are not. those and that credit-constrained are firms group into first the dividing before credit, for demand without and with firms between distinguish we can questions, survey various to combining answers By growth. firms’ hindering is credit bank of alack that mean necessarily not does in lending adecline so fall, to lending bank cause can Both credit. bank of supply the and for demand the disentangle properly to important is it loans, bank 2013-14 in the aftermath of the crisis (involving 20,321 crisis firms). the of 2013-14 aftermath in the (involving 7,047 in firms); BEEPS and conducted was which V, crisis the of time the at in 2008-09 out IV, carried was which (involving crisis financial global the 7,053 firms); BEEPS preceded that boom credit during the in 2005 conducted was III, which –BEEPS survey BEEPS the of rounds three uses chapter This characteristics. firm-level other of number alarge on information elicits also survey The operations. firms’ to obstacles represent finance) to (including access environment business the of features various which to extent the determine to seeks and firms of sample arepresentative of main managers or owners the with interviews face-to-face involves survey BEEPS The Bank. World the and EBRD bythe (BEEPS) conducted Survey Performance Enterprise and Environment Business the on draws chapter this credit, bank new access to ability in their adecline experienced have region transition the in firms which to To extent the gauge view firms’ constraints: Credit say and banks firms what constraints: Credit 4 3 CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH GDP of the individual countries. The figure for 2015 is forecast. is 2015 for the by figure The weighted and countries. effects individual exchange the of GDP foreign for adjusted is growth Credit awhole. as region transition Note: Source: CHART 2.1. 2.1. CHART

any loans or lines of credit in the last fiscal year? fiscal last the in credit of lines or loans any “ K16 asks: question (1993). BEEPS Jappelli and Cox instance, for See, SMEs. as classified be therefore can and employees than 250 fewer have firms BEEPS all of percent 95 Over in place took – countries. firms other 2013-14 all in and Russian 2011-12of Russia in sample larger a surveyed and time first eastern the and for (SEMED) southern the in Mediterranean countries four the included –which survey BEEPS latest the for work Field Nominal domestic credit growth (per cent) Chart 2.2 shows that demand for bank credit has waned waned has credit bank for demand that shows 2.2 Chart In order to gain an understanding of SMEs’ ability to access access to ability SMEs’ of an gain understanding to In order -20 -10 This chart shows the annual growth rate of nominal domestic credit to the private sector for the the for sector private the to credit domestic nominal of rate growth annual the shows chart This 10 20 30 40 50 0 IMF, national authorities via CEIC Data, BIS and authors’ calculations. calculations. authors’ and BIS Data, CEIC via authorities IMF, national

2004 Slowing credit growth across the transition region region transition the across growth credit Slowing

2005

2006

4 2007 Aggregating individual firms’ responses individual firms’ responses Aggregating

2008 ” For firms that answer “ answer that firms ” For 2009

2010

2011 Did the establishment apply for for apply establishment the Did No

”, question K17 asks: “ K17 asks: ”, question 2012

2013

2014

What What

3 2015

31

CHART 2.2. Percentage of firms that need a loan CHART 2.3. Credit-constrained firms as a percentage of firms that need a loan

100 100

90 90 Egypt Belarus Belarus 80 80 Azerbaijan Mongolia 70 70 Azerbaijan 60 60

50 50 Turkey 40 40

30 Kosovo 30 20 Latvia 20

10 10 Slovenia Slovenia Turkey 0 0 2005 2008-09 2013-14 2005 2008-09 2013-14

Source: BEEPS III, IV and V. Source: BEEPS III, IV and V. Note: BEEPS III values are based on simple intra-country means while values for BEEPS IV and V are Note: BEEPS III values are based on simple intra-country means while values for BEEPS IV and V are weighted averages. weighted averages.

from 68 per cent in 2005 to 60 per cent in 2008-09 and to just CHART 2.4. Percentage of credit-constrained firms in 2013-14 48 per cent in 2013-14.5 This decline reflects the fact that, in Egypt 85 Azerbaijan 77 the presence of slow economic growth, fewer firms need loans Kazakhstan 76 Ukraine 75 Jordan 69 Montenegro 67 to expand their production capacity. This reduced demand has Bulgaria 66 Russia 66 Moldova 65 been only partially and temporarily offset by increased demand Albania 62 Latvia 61 Tajikistan 59 for working capital and other bridge financing on the part of firms FYR Macedonia 57 Croatia 57 Kyrgyz Rep. 57 Hungary 55 whose cash flows have been negatively affected by the financial Serbia 51 Lithuania 49 Uzbekistan 48 crisis. In the most recent survey round, demand for credit was Armenia 47 Mongolia 46 Belarus 45 Romania 45 lowest among firms in Latvia and highest among Mongolian Kosovo 43 Tunisia 40 Slovak Rep. 37 firms. Chart 2.2 also shows that cross-country variation in firms’ Georgia 36 Slovenia 36 Morocco 34 Poland 34 average demand for credit has increased over time, reflecting the Estonia 29 Bosnia and Herz. 25 Turkey 13 fact that countries differ greatly in terms of the extent to which 0 20 40 60 80 100 they have been affected by the global financial crisis and the Source: BEEPS V. subsequent eurozone debt crisis. Note: Values are weighted averages. Chart 2.3 shows that there has also been a marked increase in the percentage of credit-constrained firms – that is to say, firms that need additional credit but are either rejected when they apply for a bank loan or feel discouraged from applying for such a loan. In the most recent survey, 51 per cent of all firms that needed credit reported that they had trouble accessing it. This figure was significantly lower in 2005 (34 per cent) and 2008-09 (46 per cent), indicating that credit conditions for SMEs have tightened further in the wake of the global financial crisis. This probably reflects the more or less seamless transition from the global 15 per cent in 2008-09 to 36 per cent in 2013-14. In Turkey, on financial crisis to the eurozone debt crisis, which had a further the other hand, continued accommodating monetary conditions negative impact on the balance sheets of many European banks resulted in the percentage of credit-constrained firms declining operating affiliate networks across the EBRD region. further in that period, falling from 28 per cent to a record low There is substantial cross-country variation in firms’ ability of just 13 per cent.6 Other countries with relatively loose credit to access bank loans and, as with credit demand, this variation conditions include Bosnia and Herzegovina (where only 25 per has increased over time. Chart 2.3 shows that Slovenian firms cent of firms that need a loan are credit-constrained), Estonia experienced the easiest access to credit in both the 2005 and (29 per cent) and Morocco and Poland (both 34 per cent). the 2008-09 surveys, but Turkey holds this distinction in the At the other end of the spectrum, there are countries like most recent survey. Slovenian banks have become much more Azerbaijan and Egypt where the large majority of firms that need a restrictive owing to the recent turmoil in the country’s banking loan are credit-constrained. In the latest survey round, which also sector and the increasing level of non-performing loans. As a included the four SEMED countries, this percentage was as high result, the percentage of credit-constrained firms in Slovenia as 77 and 85 per cent in Azerbaijan and Egypt respectively. As more than doubled between the last two surveys, rising from Chart 2.4 shows, Kazakhstan (76 per cent) and Ukraine (75 per

was the main reason the establishment did not apply for any line of credit or loan in the last fiscal year?” “Did not think it would be approved” to K17. For firms that answer “Yes” to K16, question K18a asks: “In the last fiscal year, did this establishment 5 A very similar trend is observed when the sample of countries is kept constant across the three survey apply for any new loans or new credit lines that were rejected?” Firms that answer “Yes” to K16 and “No” rounds. to K18a are considered to be unconstrained, as they were approved for a loan, while firms are credit- 6 The annual growth rate of nominal credit has averaged almost 30 per cent in Turkey over the last decade. constrained if they answer “Yes” to K18a (that is to say, they were rejected) or they answer “Interest rates are not favourable”, “Collateral requirements are too high”, “Size of loan and maturity are insufficient” or 32 TRANSITION REPORT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 2015-16 REBALANCING FINANCE

CHART 2.5. Reasons why SMEs are credit-constrained

2005 2008-09 2013-14 10% 16% 13% 11% 23%

6% 3% 14%

9% 11%

13%

89% 34% 48%

Rejected application Discouraged Complex procedures Interest rates Collateral requirements Size and maturity Other

Source: BEEPS III, IV and V, and authors’ calculations. Note: BEEPS III values are simple intra-country means. Other values are weighted averages. The size of each circle is proportionate to the percentage of credit-constrained firms in the relevant survey round.

cent) also had relatively high percentages of credit-constrained (also 35 per cent) and Kazakhstan (38 per cent). In 2013-14 the firms. Banks in both of these countries have been hit hard by situation in Georgia was unchanged, the percentage of credit- the global financial crisis and a rapid decline in the availability of constrained firms had increased to 66 per cent in Bulgaria, external bank funding. and it had more than doubled to 76 per cent in Kazakhstan. This Chart 2.5 provides more information about why firms are chapter will look at how these large differences in the tightening credit-constrained (with the increases in the size of the circles of credit constraints can be explained by the extent to which reflecting the growing percentage of credit-constrained firms). The banking systems had to rebalance in the wake of the global light blue segment shows that both before and after the financial financial crisis. crisis around 10 per cent of all credit-constrained firms had Are there also differences within countries in firms’ ability to been rejected by a bank. In contrast, at the height of the crisis access credit? To answer this question, a regression analysis this percentage was more than twice as high (standing at 23 per has been carried out in order to systematically relate firm-level cent). A further breakdown available in the last two survey rounds characteristics to the probability of being credit-constrained shows various different reasons why firms are discouraged from (while keeping all country-level characteristics constant). This applying for bank credit. This breakdown shows that in 2013-14 shows that a number of firm-level characteristics are robust around half of credit-constrained firms indicated that the interest predictors of credit constraints across all three survey rounds. rates charged by banks were prohibitively high. In addition, In particular, Chart 2.7 shows – using the most recent survey 14 per cent were discouraged from applying because they data (that is to say, data for 2013-14) – that small firms, non- thought the application procedures were too complex, while exporting firms and firms without audited financial statements 9 per cent did not apply because they thought the collateral are all more likely to be credit-constrained. This suggests that requirements were too stringent. less transparent firms have more difficulty accessing credit. While firms in the region have, on average, become more Reassuringly, growing firms (that is to say, those that have credit-constrained over the last 10 years, there is considerable recorded positive growth in the number of employees over the cross-country heterogeneity. As Chart 2.6 shows, only three last three years) have a higher probability of accessing credit countries – Poland, Tajikistan and Turkey – have seen an than stagnating firms. Interestingly, various other firm-level improvement in firms’ ability to access credit over the last characteristics – including foreign ownership and female decade (and even that improvement has been only slight). In ownership – are not significantly correlated with the probability another small group of countries – a group including Belarus, of being credit-constrained. FYR Macedonia and Georgia – there has been virtually no change (these are the countries on the 45-degree line). The chart also shows that there is substantial cross-country variation in the tightening of credit constraints, even among countries that displayed very similar levels in 2005. Look, for example, at Georgia (35 per cent of firms constrained in 2005), Bulgaria 33

CHART 2.6. Changes in the percentage of credit-constrained firms: pre-crisis CHART 2.7. Credit constraints: variation across different types of firm versus post-crisis

100 Small firms 58 90 Medium-sized firms 36 80 KAZ AZE Large firms 23 70 UKR MDA MNG RUS ALB BUL TJK Audited 36 60 CRO LAT KGZ FYR SER Unaudited 50 HUN ARM 61 BEL LIT UZB ROM 40 SLO SVK GEO POL Exporters 36 30 EST BOS Non-exporters 57 20 TUR 10 Growing firms 47 0 Stagnating firms 56

Percentage of credit-constrained firms in 2013-14 0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 Percentage of credit-constrained firms in 2005

Source: BEEPS III and V. Source: BEEPS V, excluding SEMED countries. Note: BEEPS III values are based on simple intra-country means while BEEPS V values are weighted Note: Small firms have 2-49 employees, medium-sized firms 50-250 employees and large firms over 250 averages. employees. Growing firms have seen growth in the number of employees in the last three years. The chart shows the percentage of firms in each category that are credit-constrained.

CHART 2.8. Main constraints on banks’ ability to increase lending to SMEs

100 87 80 Credit constraints: banks’ view 71 The firm-level surveys used thus far show that more and more 60 56 firms are feeling constrained in their ability to access bank credit, 50 Per cent 40 not just because they are rejected when they apply for loans, 35 35 34 but also – primarily, in fact – because they are discouraged 28 27 20 13 13 from applying in the first place. This suggests that supply-side 12 12 10 considerations have played an important role in the reduction of 0 bank credit since 2008. Do banks in the region agree with this Lack of Insufficient Low interest Loan officer Lack of Lack of liquidity Lack of equity creditworthy demand rates skills information reading of the evidence? To assess this question, this chapter customers uses another survey: the EBRD’s second Banking Environment Pre-crisis Post-crisis and Performance Survey (BEPS II). As part of BEPS II, structured Source: BEPS II. face-to-face interviews were held with the CEOs of banks across Note: The bars show the percentage of banks indicating that the factor on the x-axis is one of the three main constraints preventing increases in credit to SMEs. the transition region. Among other things, those CEOs were asked a series of questions about their banks’ lending activities before and after the global financial crisis. Chart 2.8 shows the percentages of banks that mentioned a particular reason as a key constraint (that is to say, one of the top three) preventing them from lending more to SMEs. Interestingly, banks seem to pin the blame squarely on firms. In their view, the main reason for not lending more at the moment is the lack of demand for loans in general and the lack of creditworthy customers in particular. This is especially true in the post-crisis period. Moreover, very few banks indicate that their own liquidity or solvency position is a relevant factor in their ability to lend. In fact, balance sheet constraints have even become somewhat less important in the wake of the crisis. In short, the BEEPS surveys suggest that while fewer firms need credit in the post-crisis environment, those firms that do 87% are finding it much more difficult to obtain a bank loan. Banks, OF INTERVIEWED BANK CEOS on the other hand, argue that there is simply not enough demand INDICATED THAT A LACK OF for credit. Moreover, those firms that do apply for a loan are CREDITWORTHY CUSTOMERS IS A not deemed sufficiently creditworthy. Accordingly, banks have KEY CONSTRAINT ON THEIR LENDING increased the percentage of assets that are held in the form of TO SMES 34 minimum and maximum sizes observed in the EBRD region. region. EBRD the in the observed between sizes sectors maximum and banking minimum have that countries 65 of agroup are countries” invests, EBRD the which “comparator in the while countries all means region” “EBRD may 2005. to loans relate variables all for non-performing of Data vary). definitions national (albeit loans total of Non-performing banks. apercentage by as held measured equity are total loans to assets total to total of loans ratio total of the is ratio the “leverage” means banks; by funding” held deposits “wholesale credit; of private-sector ratio to the means borrowing borrowing” bank cross-border “international assets; held bank total of assets means banks” apercentage as foreign banks of “Share foreign by variables. respective the and GDP) to credit private-sector Note: CEICDevelopment Data and calculations. Indicators, authors’ Source: Note: Source: 2012. and 2005 between year each for loans total and bonds government of holdings information have their on that banks available comprises only sample The region. EBRD the in active are that banks 108 of Note: Source: government bonds loans) plusgovernment total CHART 2.11. CHART 2.10. CHART 2.9. CHART -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 Private-sector credit as a percentage Average share government bonds 10 12 14 16 18 Average government bond holdings as a percentage of government bonds plus total loans for a sample asample for loans total plus bonds government of apercentage as holdings bond government Average 0 2 4 6 8 This chart shows the correlation between the size of the banking sector (measured as the ratio of of ratio the as (measured sector banking the of size the between correlation the shows chart This means. intra-country simple on based are values III BEEPS of GDP in 2005 Claessens and Van Horen (2015), Bankscope, BIS Consolidated Banking Statistics, World World Statistics, Banking Consolidated BIS (2015), Bankscope, Horen Van and Claessens BEEPS III and World Development Indicators. Bankscope. 20 40 60 80 Share offoreignbanks 0 0 0.44 2005 Banks’ holdings of government bonds (as a percentage of of (as apercentage bonds government of holdings Banks’ B -0.42 Size of banking sector and percentage of credit-constrained firms firms credit-constrained of percentage and sector banking of Size anking integration, bank funding and the size of the banking system system banking the of size the and funding bank integration, anking 2006 bank borrowing 0.68 International 20 Percentage ofcredit-constrainedfirmsin2005 2007 0.12 EBRD region 2008 Wholesale funding 0.45 40 Comparator countries 0.35 2009 0.62 Leverage 2010 FINANCE REBALANCING 2015-16 TRANSITION REPORT 0.19 60 2011 Non-performing loans -0.30

2012 -0.13

80 7 bank ownership, adjustments during the recent crisis period have have period crisis recent during the adjustments ownership, bank 2.12).Chart (see crises eurozone debt and financial recent during the changes make to forced were systems banking the in which areas very the were, unfortunately, These leverage. byincreasing and funding banking reliance on greater wholesale integration, cross-border through firms credit-constrained of percentage the reduce to managed countries transition regions, in than more Much other distinctive. fairly have to been appears Europe’s sectors banking in emerging employed model weaker.much growth the Thus, also is leverage bank with correlation The strong. less is other funding the on wholesale and financial international integration and hand one the on development banking-sector link between the countries, comparator asimilar of In size. these systems banking with countries comparator of agroup for bars) red (see correlations same the shows also 2.11 Europe? Chart emerging unique to model this was But sectors. banking its develop rapidly to crisis financial the to prior used Europe emerging that sectors. banking largest the had loans non-performing fewer and funding) deposit to (as funding opposed wholesale of use banks), greater (excluding funding bank parent from funding cross-border on dependence greater banks, foreign of percentage higher a with countries crisis, the before that shows It region. EBRD the across systems banking size such of the hand, other the and, on systems banking of characteristics various hand, one the on between, relationship the of strength the indicating bars) blue (see coefficients correlation of aset shows 2.11 Chart sectors? banking large such develop to have managed countries transition which is: question next alogical credit-constrained, limited access to credit. to access limited of complain firms fewer so systems, banking inavailable larger is credit More theycredit-constrained. that were firms reporting of percentage the and system banking size acountry’s of the between correlation negative strong a was there crisis financial global the before that countries, of transition for a sample shows, 2.10 Chart As expected, credit. access to firms’ ability and GDP) of apercentage as credit private-sector bytotal measured (as system banking size the of the between relationship cross-sectional the assessing by firms credit-constrained of percentage in the changes and rebalancing banking-sector between relationship the of our discussion begin to useful is It credit to Financial access rebalancing and SMEs’ years. recent and/or in lend to ability banks of the on had has willingness various countries across of rebalancing banking the systems that impact the byanalysing question this answer to seeks chapter this of remainder The right? is Who borrowers. private-sector to credit fresh of supply the on aconstraint be to structure sheet own balance their consider few banks very 2.9). And Chart (see sector private the to loans of expense the at bonds, government CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH

Post-crisis data paint a very similar picture. similar avery paint data Post-crisis The first panel of Chart 2.12 indicates that, in terms of foreign foreign of terms in that, 2.12 indicates Chart of panel first The model economic the describe Together, characteristics these being firms of probability the reduce systems banking larger If 7

private-sector credit in each country, averaged over the countries of the EBRD region. Panel C shows total loans as a percentage of total deposits held by banks in each country, averaged over the countries of the EBRD EBRD the of region. EBRD countries the of the over countries averaged the over country, each in averaged banks by held country, each in banks deposits by held total of equity total of apercentage as loans apercentage total as Cshows Panel assets total region. EBRD Dshows the of Panel region. countries the over averaged country, each in credit private-sector Note: Source: Baltic states, accelerated after the collapse of Lehman Brothers Brothers Lehman of collapse the after accelerated states, Baltic the and Hungary Croatia, Bulgaria, as such in countries 2006 as early as began deleveraging cross-border This region. transition in the banks to banks byBIS-reporting lending in cross-border 2013. in businessman aUkrainian to subsidiary Swedbank’s bank Ukrainian Swedish of sale in 2012 the and investor adomestic to Forum Bank subsidiary Ukrainian its of sale Commerzbank’s bank German in 2013, businessman ATF alocal to Bank subsidiary Kazakh its of sale UniCredit’s include examples Prominent 2.2). Box also (see investors domestic sellingto by countries specific exited banks foreign in some as set decline agradual which 2010, after in peaked ownership bank Foreign investment. cross-border of source stable arelatively is investment direct foreign that showing 1 in Chapter evidence in is line This with limited. relatively been funding C. Wholesale banks foreign of Share A. CHART 2.12. 2.12. CHART Per cent 100 120 130 110 Per cent 70 80 90 Panel A shows assets held by foreign banks as a percentage of total bank assets in each country, averaged over the countries of the EBRD region. Panel B shows cross-border borrowing by banks as a percentage of of apercentage as banks by borrowing cross-border Bshows Panel region. EBRD the of countries the over averaged country, each in assets bank total of apercentage as banks foreign by held assets Ashows Panel 10 20 30 40 50 60 70 The second panel of Chart 2.12 shows a very rapid decline decline rapid avery shows 2.12 Chart of panel second The 0 Bankscope, Claessens and Van Horen (2015), BIS Consolidated Banking Statistics, World Development Indicators, CEIC Data and authors’ calculations. calculations. authors’ and Data CEIC Indicators, Development World Statistics, Banking Consolidated (2015), BIS Horen Van and Claessens Bankscope, 2005 2005 Banking-sector adjustment across the transition region region transition the across adjustment Banking-sector 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 D. Leverage bank borrowing B. International Per cent Per cent 10 15 20 10 11 0 5 9 7 8 2005 2005 2006 2006 2007 2007 48 TOO HIGH LOANS BECAUSE INTEREST RATES ARE DISCOURAGED FROM APPLYING FOR OF CREDIT-CONSTRAINED FIRMS ARE 2008 2008 2009 2009 % 2010 2010 2011 2011 2012 2012 35 2013 2013 36 TRANSITION REPORT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 2015-16 REBALANCING FINANCE

and continues today in the wake of the eurozone debt crisis. CHART 2.13. Banking-sector adjustment and aggregate credit constraints The third panel shows that, after peaking in 2008, banks’ reliance on wholesale funding (as opposed to deposit funding) 0.4 0.36 has fallen significantly. The average ratio of total loans to 0.3 customer deposits declined from 120 per cent in 2008 to 97 per 0.2 cent in 2013. In particular, banks that had rapidly expanded their 0.1 loan portfolios on the basis of very small deposit bases had to 0.0 reduce their lending quickly, thereby contributing to the increase -0.1 -0.11 in the percentage of credit-constrained firms. -0.2 -0.29 The fourth panel shows that banks have also been adjusting -0.3 -0.33 their leverage. Before the crisis many banks operated with high -0.4 -0.46 asset-to-equity ratios (termed “leverage multiples”). The panel -0.5 shows the procyclical behaviour of this leverage multiple across Change in share Change in Change in Change in leverage Change in of foreign banks international bank wholesale funding non-performing loans the transition region. It peaked just before the collapse of Lehman borrowing Brothers and has been declining ever since as banks have Source: BEEPS III, IV and V, Claessens and Van Horen (2015), Bankscope, BIS Consolidated Banking Statistics, World Development Indicators, CEIC Data and authors’ calculations. strengthened their equity bases while shedding or writing off non- Note: The chart shows the correlation coefficients between changes in the percentage of firms that are performing assets. credit-constrained and changes in the respective variables. “Share of foreign banks” means assets held by foreign banks as a percentage of total bank assets; “international bank borrowing” means the ratio of Chart 2.13 shows that the increase in credit constraints cross-border borrowing to private-sector credit; “wholesale funding” means the ratio of total loans to total across countries is strongly correlated with the various ways deposits held by banks; “leverage” is the ratio of total assets to total equity held by banks. Non-performing loans are measured as a percentage of total loans (albeit national definitions of non-performing loans may in which the region’s banking systems have had to adjust. The vary). Changes are calculated over the period from 2005 to 2013. increase in credit constraints – aggregated at the country level – has been most pronounced in countries that have experienced a decline in cross-border borrowing by banks, a decline in banks’ use of wholesale funding (as opposed to deposit funding), a decline in bank leverage and an increase in the percentage of non-performing loans on banks’ balance sheets. Table 2.1 analyses the impact that such rebalancing has on credit constraints at the firm level. In the reported regression estimates, the dependent variable is the probability that a firm was credit-constrained in 2013-14. The explanatory variables are the country-level variables shown in Chart 2.12, plus the percentage of credit-constrained firms in 2005 (which is calculated at the country level). That last variable absorbs unobserved cross-country variation affecting firms’ ability to SMEs’ access to credit: a local view access credit. The regression framework also controls for a The analysis thus far indicates that financial adjustment in battery of (unreported) firm-level characteristics. banking systems across the transition region goes a long way The results in columns 2 to 5 of Table 2.1 indicate that the towards explaining why SMEs in some countries have seen their probability of a firm being credit-constrained in 2013-14 was funding conditions deteriorate much more than their counterparts substantially higher in countries where, in the previous five in other countries. However, there are three reasons why it is years, banks had to adjust their international and wholesale unlikely that the rebalancing of banking systems can explain all of borrowing more, where they had to deleverage more, and where the variation in credit constraints across and within countries. non-performing loans increased the most. A direct comparison First, the BEEPS surveys indicate that a significant percentage of these variables indicates that changes in cross-border and of firms complain about cumbersome loan application wholesale funding are particularly strongly associated with procedures and collateral requirements. These are structural increases in credit constraints (see column 6). These results, issues that are largely unrelated to bank funding. Second, almost which have plenty of support in academic literature,8 can help to all bank CEOs who were interviewed as part of the BEPS II survey explain why Chart 2.6 shows such strong cross-country variation voiced serious concerns about the creditworthiness of SMEs in the tightening of credit conditions for SMEs. For example, while applying for loans. This, too, suggests that banks’ own funding in 2005 the percentage of credit-constrained firms was about problems, while important, do not tell the full story. Third, BEEPS 35 per cent in Georgia, Bulgaria and Kazakhstan, it remained data reveal persistent large differences between opaque and unchanged in Georgia but increased sharply in the other two relatively transparent firms in terms of the probability of being countries. In line with the results in Table 2.1, cross-border bank credit-constrained. All three of these observations suggest that lending to Georgia declined by only 15 per cent while cross-border structural causes, over and beyond adjustments in banking lending to Bulgaria and Kazakhstan fell by 70 and 80 per cent systems, continue to prevent the efficient matching of firms to respectively. banks in many transition countries.

8 See Popov and Udell (2012), De Haas and Van Lelyveld (2014) and Ongena et al. (2015). 37

TABLE 2.1. Banking-sector adjustment and firm-level constraints in 2013-14

Dependent variable: credit-constrained dummy (2013-14) (1) (2) (3) (4) (5) (6)

Change in share of foreign banks (2007-12) 0.038 0.018

(0.300) (0.599)

Change in international bank borrowing (2007-12) -0.255* -0.313**

(0.090) (0.029)

Change in wholesale funding (2007-12) -0.475*** -0.439*

(0.003) (0.063)

Change in leverage (2007-12) -0.549** -0.125

(0.049) (0.714)

Change in non-performing loans (2007-12) 0.031** 0.004

(0.050) (0.884)

Percentage of credit-constrained firms in 2005 1.806** 1.816*** 1.533*** 2.271*** 1.662*** 1.992***

(0.020) (0.000) (0.003) (0.003) (0.004) (0.001)

Number of observations 6,285 6,285 6,285 6,285 6,296 6,177

Firm-level covariates Yes Yes Yes Yes Yes Yes

Locality-level covariates Yes Yes Yes Yes Yes Yes

Adjusted R2 0.076 0.080 0.083 0.080 0.076 0.088

Source: BEEPS, BIS, Claessens and Van Horen (2015), Bankscope and EBRD (data on non-performing loans). Note: This table reports the results of probit regressions explaining the probability of a firm surveyed as part of the 2013-14 BEEPS survey indicating that it was credit-constrained. Observations are weighted on the basis of the number of firms in the country that participated in the survey. Standard errors are clustered by country. P-values are reported in parentheses: * = p<0.10; ** = p<0.05; *** = p<0.01.

Indeed, it is likely that such structural causes – while already This assessment of the matching of banks and firms uses present prior to the crisis – have only gained in importance in data from the 2013-14 BEEPS survey. For each borrowing firm, the last couple of years. In the wake of the crisis, firms’ default this survey round provides information on the identity of the most risk has increased considerably, with the result that collecting recent lender. Moreover, the BEPS II survey provides detailed reliable information on loan applicants has become both more information on the various branches that are present in the town important and more difficult. For instance, a recent report by the or city where each interviewed firm is located. This produces a Institute of International Finance (IIF)9 suggests that screening dataset in which each firm can be linked to all potential lenders loan applicants has become more challenging following the in its immediate vicinity. The question is then why a firm borrows shift in the global credit cycle. One reason for this is that banks from bank A, rather than from bank B, C or D? cannot now rely as much on collateral and hard information and Table 2.2 shows the results of regression analysis exploring need to look more closely at firms’ prospects. This requires more this question. The first column of the table shows that, given a subtle judgements, including judgements about the ability and certain population of bank branches in a locality, a firm is more commitment of firms’ owners and management.10 Some banks likely to borrow from a foreign bank and less likely to borrow from may be better equipped to produce such judgements during a small bank (defined here as a bank with assets totalling less downturns than others. than €1 billion). This indicates that, all else being equal, firms In order to analyse which factors determine successful prefer to borrow from foreign banks rather than domestic banks “matches” (that is to say, new lending relationships) between where both types of bank are available. Likewise, larger banks firms that are in need of a loan and banks that are able and appear to be preferred to smaller ones. willing to lend to them, this section uses detailed micro data on Second, the regression framework assesses the role of individual firms and surrounding bank branches. When a firm bank-lending techniques, particularly the difference between needs a loan, it usually has various banks to choose from in the “relationship lenders” and “transaction lenders”, as well as locality where it is based. What factors contribute to the choice of the efficiency of banks’ lending procedures. On the basis of a particular bank? BEPS II interview data, it is possible to classify banks in the

9 See Institute of International Finance (2013). 10 See Beck et al. (2014). 38 TRANSITION REPORT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 2015-16 REBALANCING FINANCE

transition region as either relationship or transaction lenders. TABLE 2.2. Determinants of the matching of firms and banks Relationship lenders usually provide several consecutive loans Dependent variable: match to the same borrower, thereby building up extensive proprietary dummy (0/1) (1) (2) (3) (4) (5) information about that borrower. This in-depth knowledge may help relationship lenders to continue to lend to firms (particularly Foreign bank 0.013*** 0.010* smaller and more opaque firms) when economic uncertainty (0.000) (0.050) increases – for example, during a crisis or a recession. In contrast, transaction lenders usually only lend once or twice to Small bank -0.078*** -0.088*** a borrower, doing so mainly on the basis of publicly available (0.000) (0.000) information on that borrower (which is often processed automatically using a credit-scoring model) or simply relying on Relationship bank 0.014*** 0.010** collateral. This can be effective during boom periods but may (0.001) (0.031) become problematic when screening loan applicants becomes more difficult during a cyclical downturn, as the aforementioned No. of hierarchical layers -0.015*** -0.007*** IIF report suggests. (0.000) (0.001) The results in column 2 show that SMEs are more likely to match with a relationship lender rather than a transaction lender. Court enforcement 0.012** 0.009* This suggests that relationship lenders have a competitive advantage in a difficult lending environment as they are better (0.017) (0.082) able to screen new borrowers and distinguish between good Liquidity is constraint -0.024*** -0.032*** and bad risks.11 The results in column 2 also show that SMEs are more likely to borrow from banks with fewer layers of (0.009) (0.003) decision-making in their loan application procedures. This Firm-level fixed effects Yes Yes Yes Yes Yes means that a firm will prefer to borrow from a bank where a loan decision only involves one or two decision-making stages No. of observations 38,385 29,693 30,768 29,595 26,541 rather than a competitor where each loan application has to be R2 0.061 0.052 0.049 0.052 0.079 approved by, say, three or four departments or managers.

The importance of such efficiency as a determinant of the Source: BEEPS V, BEPS II, Claessens and Van Horen (2015) and Bankscope. matching of firms to banks is in line with the earlier evidence Note: This table reports the results of probit regressions explaining the probability of a firm surveyed as part of the 2013-14 BEEPS survey borrowing from a particular bank in its locality. P-values are reported in from the BEEPS survey showing that a large number of parentheses: * = p<0.10; ** = p<0.05; *** = p<0.01. firms needing credit complain about cumbersome loan application procedures. Column 3 looks at the impact of the perceived quality of the legal system, particularly the ability of courts to enforce legislation on pledges. Indeed, evidence suggests that banks which perceive pledge and mortgage legislation to be of a high quality focus more on mortgage lending and lending to private-sector clients more generally, rather than lending to state-owned enterprises.12 The results in Table 2.2 show that firms are more likely to end up borrowing from banks that are more confident in the ability of local courts to enforce pledge legislation. This is in line with recent cross-country evidence showing that effective collateral legislation for movable assets can have a significant impact on the volume and sectoral allocation of bank lending.13 Lastly, as expected, the data show that firms are less likely to end up borrowing from a bank that indicated during the BEPS II survey that limited liquidity was one of the top three obstacles preventing it from lending (see column 4). This makes sense, as banks that are financially sound will compete more aggressively for market share.

11 In line with this, Beck et al. (2014) show that while relationship lending does not affect credit constraints during a credit boom, it alleviates such constraints considerably during a credit crunch. This accommodative effect of local relationship lending is especially strong for relatively opaque borrowers such as small firms and firms without audited financial statements. 12 See De Haas et al. (2010). 13 See Calomiris et al. (2015). 39

Conclusion information and need to look more closely at firms’ prospects. Credit conditions for small businesses have tightened The results in this chapter are therefore a warning to banks and significantly in recent years, both during and after the global their shareholders against adopting an excessively short-termist financial crisis. Structural adjustments in banking systems – approach and reducing costs by laying off loan officers and other particularly reduced reliance on cross-border and wholesale frontline staff who deal directly with borrowers. In the medium funding – explain a large percentage of this tightening. The term, such cuts may negatively affect banks’ ability to determine composition of national banking markets also plays an important whether SMEs have adequate growth prospects. role. Indeed, this chapter has shown that when SMEs choose Third, effective and efficient lending to SMEs can also be between various banks in their local town or city, they tend to stimulated by institutional improvements at the country level. borrow from financially sound banks that have less hierarchical Well-functioning credit registries – through which banks and lending procedures, greater faith in the courts and a focus on other lenders are required to share information about the quality longer-term lending relationships. This suggests that financial, of borrowers – have been shown to improve SMEs’ access to organisational and institutional issues all have a key role to play credit over time. Banks that can easily access trustworthy “hard” in determining firms’ ability to access credit. data on borrowers will also be incentivised to invest more in The first important implication of the findings in this chapter building up proprietary “inside” information about borrowers.14 is that it matters how banks reach out to prospective SME Thus, the introduction of credit registries and the use of borrowers. Surveys of firms reveal that many small businesses relationship lending need not be mutually exclusive and may that are in need of a loan are discouraged from applying for instead complement each other. credit by cumbersome and lengthy application procedures. This Fourth, high levels of non-performing loans continue to weigh happens relatively often in countries such as Armenia, Egypt, on the balance sheets of many banks (see Macroeconomic Kazakhstan and Tajikistan. Moreover, banks that have lengthy Overview). Not only have authorities in various countries been loan application procedures involving many hierarchical layers slow to act, recapitalisations of banks have in some cases also tend to be less successful at competing for business. Countries been too limited in scope. Poorly designed recapitalisations where loan application procedures for SMEs tend to be relatively may prevent banks from fully tackling their non-performing hierarchical (and further streamlining may be useful) include loan problems, such that they keep “evergreening” bad loans Albania, Croatia and Tajikistan. Importantly, the streamlining instead.15 In such cases, lending to SMEs will fail to recover. of loan application procedures is within the remit of banks themselves and does not require changes to the institutional or legal environment. Second, the results in this chapter (and a growing body of academic literature) suggest that relationship banks have a special role to play as a source of finance for SMEs. This is particularly true during periods of economic uncertainty when loan officers cannot rely as much on collateral and hard

WELL-FUNCTIONING CREDIT REGISTRIES HAVE BEEN SHOWN TO IMPROVE SME ACCESS TO CREDIT

14  See, for instance, Karapetyan and Stacescu (2014). 15 See Giannetti and Simonov (2013) for evidence from Japan. 40 TRANSITION REPORT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 2015-16 REBALANCING FINANCE

BOX 2.1. BEYOND BANKS: ALTERNATIVE SOURCES OF CHART 2.1.1. Percentage of investment in plants and equipment that is CREDIT IN THE TRANSITION REGION financed through leasing

Non-bank financial intermediation can help companies to access United Kingdom 31 finance when traditional bank lending is not available, either because Estonia 23 a firm has limited collateral or because there is a general tightening United States 22 of lending conditions in the aftermath of a financial crisis. Financial Germany 17 Slovenia 16 intermediation outside of the regular (and regulated) banking system Slovak Rep. 16 is sometimes referred to as “shadow banking”, a catch-all term that Latvia 14 often covers securitisation, as well as lending by unregulated finance Poland 14 companies, money market funds, hedge funds and securities lenders. Lithuania 14 While the increasing importance of shadow banking has been Turkey 7 Romania 4 identified as a financial stability issue in the United States and Europe, 0 5 10 15 20 25 30 35 its scale and impact have been relatively limited thus far in emerging Source: White Clarke Group Global Leasing Report 2014 (based on Leaseurope and national leasing markets (with the exception of China). In Bulgaria, Croatia and Romania associations). such intermediaries are estimated to account for between 18 and Note: Data are for 2013. 20 per cent of financial sector assets while in Turkey and Russia they hold 10 and 3 per cent of financial sector assets respectively.16 The bank-dominated transition region could therefore benefit from the further diversification and rebalancing of its financial sector, provided that such alternative funding sources are embedded in a proper legal Factoring and institutional framework (see Annex 2.1). Leasing and factoring, in Factoring – the sale of accounts receivable – remains a relatively modest particular, are two promising alternative sources of credit for SMEs in part of the financial sector in the EBRD region when compared with the region. most advanced economies. It can nevertheless play an important role Leasing in providing short-term liquidity for SMEs supplying goods and services. One advantage of factoring is that it is feasible even in challenging Leasing is an important source of alternative finance, especially for firms institutional environments where the enforcement of contracts leaves that need to finance new equipment. Leasing services are provided by something to be desired and claims on security are not always upheld. banks and their subsidiaries, independent companies and “captive” Even in such environments, however, effective factoring still requires firms linked to manufacturing companies. While the leasing sector is not reliable credit bureau information so that the factor can adequately directly regulated in some countries, it often falls under the purview of assess the creditworthiness of buyers.17 Reverse factoring, whereby a banking supervisors (which look at consolidated bank balance sheets) factor only purchases accounts receivable that are linked to high-quality to the extent that leasing companies are linked to banks. In the EU, the buyers, can reduce the cost of assessing the creditworthiness of large CRD IV banking directive allows individual member states to decide how numbers of buyers, especially where credit information is limited. leasing and factoring companies should be supervised. The development of the factoring sector in the EBRD region hinges Leasing’s penetration (that is to say, the extent to which it is used on further legal measures to increase the efficiency and reduce the to finance fixed investment in plant and equipment) tends to be lower legal uncertainty of factoring transactions, as is outlined in more across central Europe and the Baltic states (CEB) than it is in more detail in Annex 2.1. Turkey is a good example of how better legislation mature leasing markets such as the United States, Germany and the can boost the factoring sector, with factoring assets there increasing United Kingdom, although there is a considerable degree of variation by around 20 per cent per year since 2006 (albeit from a very low (see Chart 2.1.1). In most other EBRD countries of operations, leasing base). This development has been supported by the fact that factoring markets remain even shallower. companies have been regulated by the country’s Banking Regulatory and The central European leasing sector is characterised by a high degree Supervisory Agency since 2006. In 2012 new legislation brought further of concentration, foreign ownership and a strong focus on the leasing credibility and transparency to the sector. Another recent example is of cars and other road transport vehicles. Machinery and industrial the adoption of a new law in Croatia in 2014 which established a well- equipment account for only around a quarter of leased assets. SMEs calibrated legal framework to increase the efficiency and legal certainty that prefer leasing to traditional bank funding tend to do so not only of factoring. because it allows them to access finance without additional collateral over and above the financed asset but also because they appreciate the favourable tax treatment that it enjoys in many countries, as well as the speed with which leasing contracts are typically approved.

16 See Ghosh et al. (2012) and Financial Stability Board (2014). 17 See Klapper (2006). 19 18 ee Claessens and Van Horen (2015). Horen Van and Claessens ee  Foreign banks” refers only to subsidiaries. Branches of foreign banks are not taken into account in this this in account into taken not are banks foreign of Branches subsidiaries. to only refers banks” Foreign  S analysis. analysis. “ banks by the end of 2007. of end the by banks foreign-owned of hands the in were awhole) as region EBRD the across cent (36 per assets bank total of percentage alarge trend, this of result a As Europe. western in banks for especially in, invest to area attractive aparticularly was region EBRD The countries. other –in branches or subsidiaries either – affiliates with banks of number the in increase steady a saw crisis financial global 2008-09 the preceding decade The more acquisitions. distant and recent more smaller, selling by operations foreign their consolidate to banks parent crisis-affected of desire the by partly and countries relevant the in markets banking the of attractiveness perceived the in changes by partly driven are developments These declines. sharpest the experienced has altogether, country the left have banks foreign of number a where Ukraine, years. five last the over decreased has banks foreign of share market the region, EBRD the in 19 In equally. countries countries destination all affected not has operations domestic and foreign banks’ operations. international their reduce to been has that doing of way One crisis. the of wake the in requirements capital stringent more with comply and profitability restore sheets, balance their strengthen to need a particular had have banks parent European western that fact the reflects difference This 11 to cent. per cent 13 per 2007 2013, and from falling between slightly only declined banks foreign by controlled assets bank of share global the Indeed, world. the of parts other in observed that than stronger much been has activity bank foreign in decline 2013.– in This lower points –10 percentage cent 26 per just at standing substantially, caveats. important some with “yes”, is but answer The markets? core their on focusing to back gone have banks multinational as trend of Colombia. Davivienda Banco to Honduras and Salvador El Rica, Costa in operations its sold has HSBC bank British while operations, Colombian Santander’s bought recently Corpbanca Chile’s instance, For well. as world the of parts other in prevalent being region, EBRD the to unique means no by is regionalisation banking increased of trend This Kazakh-owned). became but Italian-owned was (which Kyrgyzstan in Bank) ATF (formerly Bank (again) to and Optima Turkey’s of Denizbank sale Sberbank the include examples Other Sberbank. Russia’s to network subsidiary European and eastern central Volksbank’s bank Austrian of sale the was trend this of example notable most the Perhaps grow. to continued has countries non-OECD in based banks foreign of number the time, same the At sharply. declining before 2008, until steadily increased countries OECD from banks foreign of number the shows, 2.2.2 Chart As opportunities. investment these seize to able and willing were region the from banks well-capitalised crisis, financial global by the weakened were banks parent European western of anumber When region. the from owners strategic to banks parent European western from shifted Belarus. and Azerbaijan in observed being increases strongest the with 12 countries, in presence their increased actually have banks foreign THE RISE RISE THE ON BANKING “EAST-EAST” BANKS: FOREIGN 2.2. BOX Interestingly, Chart 2.2.1 shows that this rebalancing of multinational multinational of rebalancing this that 2.2.1 shows Chart Interestingly, declined has banks foreign by held assets total of percentage The Foreign bank ownership in the EBRD region has, to some extent, also also extent, some to has, region EBRD the in ownership bank Foreign 19 18 Meanwhile, Chart 2.2.1 also shows that that shows 2.2.1 also Chart Meanwhile, Has the global financial crisis reversed this this reversed crisis financial global the Has included in the non-OECD group. are non-OECD Korea the in South and included Slovenia Republic, Slovak the Poland, Hungary, 2000. Republic, Czech after the member that OECD an Note became only that or member OECD an not are that countries in banks parent by registered owned banks foreign are banks” “Non-OECD earlier. or 2000 year the in member OECD Note: Source: years. both for available information asset have that banks on based are shares market Calculations the in banks. points foreign of percentage 20 10 and between of declines change. saw point countries seven percentage agiven instance, For experienced that countries of number the shows bar Each countries EBRD all for 2013 and 2007 operations. of between banks) foreign by held are that assets bank total country’s Note: Source: in the global economy. global the in markets emerging of role growing the reflects it as stay, to here probably is banking “east-east” of prominence increased the that is however, evident, is What unclear. remains overall out play will effects these How know-how. and techniques risk-management and lending art state-of-the of transfer the for scope less be may there hand, other the On borrowers. opaque more to lend to position abetter in thus and information “soft” process and collect to placed better be also may They invest. they which in countries the of needs specific the to suited better are that techniques them with bring may countries nearby from investors strategic hand, one the On employs. it model business what and based is bank parent the where on depending substantially differ can banks foreign by presented risks and benefits the that suggests literature Academic ownership? of CHART 2.2.1. 2.2.1. CHART CHART 2.2.2.CHART Number of banks Number of countries 10 100 150 200 250 300 350 6 7 8 9 0 1 2 3 4 5 50 “OECD banks” are foreign banks owned by parent banks registered in countries that became an became that countries in registered banks parent by owned banks foreign are banks” “OECD a of percentage (the banks foreign of share market the in changes point percentage shows chart This What are the possible consequences of this change in the pattern pattern the in change this of consequences possible the are What 0 Claessens and Van Horen (2015). Horen Van and Claessens (2015). Horen Van and Claessens

exit 1 1995 0

1996 Decrease inshareforeignbanks >50% Cross-country variation in banking disintegration disintegration in banking variation Cross-country Changes in bank ownership across the EBRD region (1995-2013) region EBRD the across ownership bank in Changes

1997 0 40-50% 1998 30-40% 1 1999 1 2000 20-30% OECD banks

2001 10-20% 7

2002 0-10% 9 2003 Non-OECD banks 2004

2005 0-10% 6

2006 2

Increase inshareforeignbanks 10-20% 2007 20-30% 0 2008

30-40% 1 2009

2010 40-50% 0

2011 3 >50% 41 2012 entry 0 2013 42 TRANSITION REPORT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 2015-16 REBALANCING FINANCE

A participant in the Mongolian field experiment

BOX 2.3. MICRO CREDIT: NEITHER MIRACLE Four main lessons NOR MIRAGE Together, these studies have produced a rigorous body of evidence on the impact that micro credit has in a wide variety of settings.20 They paint There has been an intense debate in recent years between the a remarkably consistent picture and contain four main lessons: proponents and opponents of microfinance on whether micro credit can 1. I n all seven studies, micro credit failed to produce substantial lift people out of poverty. However, what this heated debate has lacked increases in borrowers’ income, so it did little to help poor is solid evidence. To fill this gap, a number of research teams around the households escape poverty. This is true both in the short term (over world have conducted randomised evaluations (in the form of large field an 18-month period) and in the longer term (over a three to six-year experiments) aimed at rigorously measuring the impact that access to period). One possible explanation for this finding is the fact that micro credit has on borrowers and their households. Studies have been while micro credit clients overwhelmingly report using loans at least conducted in Bosnia and Herzegovina, Ethiopia, India, Mexico, Mongolia, partially for business purposes, many of them also report having Morocco and the Philippines. Research has taken place in both urban used part of their loans for consumption. and rural areas and evaluated both individual-liability and joint-liability Another possible explanation is that not all borrowers are natural (group) loans. entrepreneurs. Net business ownership increased in only two of those countries (see Chart 2.3.1). Of those that used micro credit to establish or expand a small business, some borrowers were more successful than others. Although business investment and expenses increased in several countries, researchers did not find any overall impact on borrowers’ profits in Bosnia and Herzegovina, Ethiopia,

20  See Banerjee et al. (2015) for an overview and a discussion of this issue. 21  See Field et al. (2013). al. et Field See 4. 3. 2. increased default rates. default increased also but term, long the in profits and term short the in investment business –increased loans repay to starting before up businesses their build to them –allowing period agrace borrowers some granting India, In growth. income borrowers’ limit also may it but defaults limiting of way effective an be can This schedule. weekly inflexible an follows usually and disbursed been has loan the after weeks two begins typically repayment instance, For credit. micro from benefit and use people how on influence abig have may design product to changes Small industry microfinance the for Implications arrangements with local banks whereby they transfer such successful successful such transfer they whereby banks local with arrangements establish could institutions Microfinance lenders. traditional of eyes the in client viable a yet not but microfinance for large too are they where apoint say, to reaching is –that stuck becoming funding more need that clients growing and successful of arisk is there moment, the At lending. SME for eligible become to entrepreneurs micro high-performing methods. screening better require will and straightforward not is differentiation initial this improving However, borrowers. promising less to loans flexible less smaller, and well perform to likely more are who clients to products flexible more larger, of offering the and market the of segmentation improved from benefit levels. poverty and rates repayment of terms in products loan flexible such of impact the evaluate to needed is research Further loans. their of use better make to borrowers help can flows income borrowers’ reflect better that schedules experienced significantly higher levels of stress in the Philippines). the in stress of levels higher significantly experienced borrowers male (albeit Philippines the and Herzegovina and Bosnia in group control the of those from different no were borrowers among levels stress overall instance, For harmful. systematically is credit micro to access that evidence no also is there Importantly, shock. income an by hit were they when assets off sell to need not did credit micro to access with households Mexico In risk. manage and shocks income against themselves insure to households helped also it Philippines the In activities. self-employment from income increasing and labour wage from earnings reducing by activities employment of mix the change to people allowed credit micro Morocco and Herzegovina and money. Bosnia In spent and earned they how deciding of terms in freedom greater enjoyed credit micro to access with households that showed teams research the by collected data the upside, the On schooling. children’s increase did not credit micro to access studies, the of six In power. decision-making in increase significant but asmall enjoy did women empowerment, on focused institution microfinance the where Mexico, In independence. or power decision-making women’s on impact no was there issue, this at looking studies four the of three in instance, For households. their in others of well-being the or well-being borrowers’ on impact atangible have to appear not did credit micro to access Moreover, borrowers. of subsectors small for observed were profits increased however, countries, some In Mongolia. or Mexico India, In addition, financial institutions could pilot better ways of helping helping of ways better pilot could institutions financial addition, In could borrowers and institutions microfinance both Accordingly, 21 In addition, or monthly repayment seasonal opening up their microfinance sector to increased competition. increased to sector microfinance their up opening currently are Tunisia) as (such that countries for pressing particularly is issue This registry. acredit via borrowers on information share to lenders problems. repayment and over-borrowing in result may which dipping”), (“double lenders various from borrow to tempted being clients some in result status. SME to graduate easily can clients micro fast-growing that ensure should departments SME and microfinance both with banks Likewise, trajectories. growth their on continue can they that afee) so (for banks those to clients (after 18 months), and there is no statistically significant difference after 3.5 years. years. 3.5 after difference significant survey endline statistically no is first there the and from are months), 18 (after results Indian The businesses. non-farm Ethiopia, for In measured is respectively. ownership levels cent per 10 and 5 the at significance micro to statistical access no had *denote ** and (which group credit). control the with credit) micro to access treatment the received (which comparing group study, the of end the at business asmall-scale operate that households of Note: Source: 22 CHART 2.3.1. 2.3.1. CHART 

See Bos et al. (2015) for evidence from Bosnia and Herzegovina. Herzegovina. and Bosnia from evidence (2015) for al. et Bos See Per cent 100 20 40 60 80 0 Lastly, the strong increase seen in competition among lenders may may lenders among competition in seen increase strong the Lastly, This chart shows, for eight randomised field experiments across seven countries, the percentage percentage the countries, seven across experiments field randomised eight for shows, chart This Banerjee et al. (2015). (2015). al. et Banerjee 24.3 Mexico 23.9 22 One possible way of preventing such problems is to allow allow to is problems such preventing of way possible One Micro credit and business ownership ownership business and credit Micro 25.4 Ethiopia 24.8 34.9 India 35.7 Control group 58.5 (individual Mongolia liability) 57.7 Herzegovina Bosnia and 50.7 Treatment group 56.6 (joint liability) 58.5 Mongolia 66.2 83.2 Morocco 81.7 99.1 Philippines 43 99.4 44 TRANSITION REPORT CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH 2015-16 REBALANCING FINANCE

BOX 2.4. FINANCIAL INCLUSION OF REMITTANCE products and financial management is one of the main reasons for RECIPIENTS people keeping their savings under the mattress. What convinced Oyniso that she and her family could benefit from opening a bank account was In many low-income countries, remittances from abroad are a major the one-on-one training session that she had with a financial adviser source of household income. In Tajikistan, for instance, annual who approached her as she was collecting her monthly payment. remittances (which are mostly from Russia) total US$ 3 billion, “After the consultation, I decided to open a deposit account,” Oyniso accounting for almost 50 per cent of the country’s GDP. Approximately explains. She is one of 2,700 Tajik participants in the training project one in four Tajik families has at least one family member working abroad who opened an account right after the training session. “I want to save and most of them regularly send money home to support their families. 100 somoni (around US$ 20) a week to buy furniture for our house,” she Most countries that rely heavily on remittances are unfortunately says. Others told the advisers that they wanted to start saving in order also characterised by limited use of formal banking services (see Chart to pay for their children’s university education, to finally buy a car or to 2.4.1). In Tajikistan, only 12 per cent of the adult population had a renovate their flat. current account at a bank in 2014, according to World Bank estimates. Staff of participating banks have also been made aware of the Even fewer Tajiks keep their savings in a bank or another type of financial importance of providing financial education to recipients of remittances. institution. As a result, annual remittance inflows are larger than the They have been advised on how to make their banks’ products more deposit base of Tajikistan’s entire banking system. attractive. As a result, banks have managed to attract new customers. The fact that so little remittance income is channelled through the “The main benefit is that ordinary people can make informed decisions banking system is a missed opportunity not only for the recipients of about their savings and gain access to modern, high-quality banking remittances themselves but also for local banks and the wider economy. services,” says Nasim Abduloev, a financial adviser at Eskhata Bank For individuals, access to formal banking services can reduce the cost of in Khujand. financial transactions and make savings easier and safer. This can help Thanks to targeted efforts to promote financial inclusion among people to smooth out consumption, particularly when faced with adverse recipients of remittances, over US$ 5 million has been deposited in economic shocks. Moreover, recent evidence suggests that when new bank accounts in Tajikistan alone (with an average deposit size of households have access to a trustworthy savings product, this can help approximately US$ 1,800) and many more participants have indicated them to save larger amounts of money and eventually use those sums to that they plan to open a bank account in the near future. Across the invest in a small-scale business.23 For the economy as a whole, having a six countries covered by the initiative, a total of 160,000 recipients larger percentage of remittances channelled through the banking sector of remittances have participated in training sessions and a total of would make it easier to channel those unused savings to other firms and US$ 25 million has been deposited in their newly opened accounts. individuals that need finance for their projects.

Increasing financial inclusion of recipients of remittances CHART 2.4.1. Remittances and bank account penetration In order to increase the percentage of remittances that are placed in safe savings accounts, a regional initiative supported by the EBRD aims 100 to introduce recipients of remittances to banking services and provide 90 80 them with financial literacy training. The initiative has been rolled out 70 across Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova 60

and Tajikistan. This financial inclusion project, which is financed by the 50 GEO EBRD’s multi-donor Early Transition Countries Fund, helps to encourage 40 AZE saving via the formal banking system and teaches potential bank 30 customers how to plan their budgets. 20 ARM KGZ MDA TJK One of the participants in the financial inclusion project is Oyniso 10 Percentage of adults with a bank account Kholikova, a new customer of Eskhata Bank in Tajikistan. She admits 0 0.1 0.5 5.0 50.0 that she did not trust banks much in the past. Consequently, when Remittance inflows as a percentage of GDP (log) she received her monthly payment from her husband, who works in Source: Global Findex database and World Development Indicators. Russia, she used to keep it at home. A lack of awareness about banking Note: Labelled countries are those participating in the financial inclusion project.

23 See, for instance, Dupas and Robinson (2013). 45

E. Field, R. Pande, J. Papp and N. Rigol (2013) References “Does the classic microfinance model discourage entrepreneurship among the poor? A. Banerjee, D. Karlan and J. Zinman (2015) Experimental evidence from India”, American “Six randomized evaluations of microcredit: Economic Review, Vol. 103(6), pp. 2196-2226. Introduction and further steps”, American Financial Stability Board (2014) Economic Journal: Applied Economics, Vol. 7(1), Global Shadow Banking Monitoring Report pp. 1-21. 2014, October, Basel. T. Beck, H. Degryse, R. De Haas and N. Van S. Ghosh, I. Gonzalez del Mazo and İ. Ötker- Horen (2014) Robe (2012) “When arm’s length is too far: relationship “Chasing the shadows: How significant is banking over the business cycle”, EBRD Working shadow banking in Emerging Markets?”, Paper No. 169. Economic Premise, No. 88, World Bank. J. Bos, R. De Haas and M. Millone (2015) M. Giannetti and A. Simonov (2013) “Sharing borrower information in a competitive “On the real effects of bank bailouts: credit market”, EBRD Working Paper No. 180. Micro evidence from Japan”, American C.W. Calomiris, M. Larrain, J. Liberti and J. Economic Journal: Macroeconomics, Vol. 5(1), Sturgess (2015) pp. 135-167. “How Collateral Laws Shape Lending and Institute of International Finance (2013) Sectoral Activity”, mimeo. Restoring Financing and Growth to Europe’s G. Chodorow-Reich (2014) SMEs, mimeo, Washington, DC. “The employment effects of credit market K.M. Kahle and R.M. Stulz (2013) disruptions: Firm-level evidence from the “Access to capital, investment and the financial 2008-09 financial crisis”, Quarterly Journal of crisis”, Journal of Financial Economics, Vol. 110, Economics, Vol. 129(1), pp. 1-59. pp. 280-299. S. Claessens and N. Van Horen (2015) A. Karapetyan and L.B. Stacescu (2014) “The impact of the global financial crisis on “Information sharing and information acquisition banking globalization”, IMF Economic Review, in credit markets”, Review of Finance, Vol. 18(4), forthcoming. pp. 1583-1615. D. Cox and T. Jappelli (1993) L. Klapper (2006) “The effect of borrowing constraints on “The role of factoring for financing small and consumer liabilities”, Journal of Money, Credit medium enterprises”, Journal of Banking & and Banking, Vol. 25(2), pp. 197-213. Finance, Vol. 30(11), pp. 3111-3130. R. De Haas, D. Ferreira and A. Taci (2010) F. Lopez de Silanes, J. McCahery, D. “What determines the composition of banks’ Schoenmaker and D. Stanišić (2015) loan portfolios? Evidence from transition “The European capital markets study: countries”, Journal of Banking & Finance, Vol. Estimating the financing gap of SMEs”, 34, pp. 388-398. Duisenberg School of Finance. R. De Haas and I. Van Lelyveld (2014) S. Ongena, J.-L. Peydró and N. Van Horen “Multinational banks and the global financial (2015) crisis: Weathering the perfect storm?”, Journal “Shocks abroad, pain at home? Bank-firm level of Money, Credit and Banking, Vol. 46, pp. evidence on the international transmission 333-364. of financial shocks”, IMF Economic Review, R. Duchin, O. Ozbas and B.A. Sensoy (2010) forthcoming. “Costly external finance, corporate investment, A. Popov and G. Udell (2012) and the subprime mortgage credit crisis”, “Cross-border banking, credit access, and Journal of Financial Economics, Vol. 97, pp. the financial crisis”, Journal of International 418-435. Economics, Vol. 87, pp. 147-161. P. Dupas and J. Robinson (2013) “Savings constraints and microenterprise development: Evidence from a field experiment in Kenya”, American Economic Journal: Applied Economics, Vol. 5(1), pp. 163-192. Introduction 1 of financial instruments. and implementation creation on the laws of efficiency the by influenced is directly finance to Access 46 EBRD’s website, show the remarkable progress that transition transition that progress remarkable EBRD’s the show website, lending. assuch and enforcement syndicated issues related covered It also collateral. financial and receivables of assignment the as as well leasing), (financial transactions forms of including quasi-security, typical sale-and-lease-back covered also assessment the mortgages), and (such pledges as interests security standard to In addition asset. of types various relevant countries. of the context and legal social economic, the to well suited were and parties various the to certainty provided inexpensive, and fast simple, were adopted solutions the whether second, and default; of event in the enforced be could which collateral that of in respect rights preferential creditors secured giving to aview with asset of types various of collateralisation the allowed regimes legal these which to EBRD’sthe of operations. countries in process collateralisation the of effectiveness and nature the examining framework, legal relevant the of assessment extensive EBRD’s an the Transition Team Legal challenges, undertook protection. sufficient creditors give to failed which rules inadequate or outdated had or transactions secured on rules no had either operated EBRD the in which countries most In 1992 process. reform the of stages at all assistance on collateral, their offers legislation modernise to countries encourage to in 1992 established was which EBRD’s The Transactions Project, Secured is offered. which it on terms improve and the credit of availability the increase can credit. of providers potential discourage may lending of riskiness perceived the increase that system legal the in inefficiencies project, new major a finance to need who plant power of a the owners or harvest forthcoming a finance to needs who afarmer make and apayment, problems liquidity overcome to capital working needs who asupplier is it Whether TO FINANCE TO ACCESS FACILITATE TO FRAMEWORKS ENHANCING LEGAL ANNEX ee, for instance, Armour et al. (2015). al. et Armour instance, for ee, S The results of this assessment, which were published on the the on published were which assessment, this of results The collateralising for potential the examined assessment The extent the first, things: two gauge to sought assessment This transition of regular assessment its of In 2014, part as of lending riskiness the which reduce Financial instruments 2.1. 2.1.

FINANCE REBALANCING 2015-16 TRANSITION REPORT

1

Source: improvements, filling in the gaps in their legal systems. legal their in fillinggaps the in improvements, granular on afocus involves which process development legal or pre/post-harvest syndication agriculturalaccounts, finance. bank over security as such methods financing modern of facilitation the example, for involve, could These improvements. further from benefit could systems performing best the even and/or morebe efficient implementedthanbetter others and financialactivities. surrounding certainty legal the increase to in place put been have rules, contractual reliable more and clearer and registries, land accurate more registries, collateral central as such tools, and Effective legal communities. international businesses and local involving both implemented, have been reforms Demanding 25 years. last over the infrastructure transaction of secured establishment have the with made countries assets. This group includes countries in the southern and eastern eastern and southern in the countries includes group This assets. commerce de French fonds the of variations on are based property movable for systems collateralisation where are third group The countries practices). established of development the (which limited has or incomplete legal provisions, or a lack of activity economic drafted poorly implementation, proper of alack of account on assets) over movable security regards as (especially expectations up to have lived not systems their but reforms implemented Asia) have in Central (which countries includes of countries group second The (SEE) Russia. and Europe (EEC), south-eastern Caucasus the and Europe (CEB), eastern states Baltic the and Europe in central found be can in practice) systems transaction secured modern (with development of levels sophisticated Fairly infrastructure. legal such of development the of terms in groups main regional three into divided be can Countries situation Current CHART A.2.1.1. A.2.1.1. CHART CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH Efficiency (0=inefficient, 100=very efficient) Most transition countries are now in the second phase of the of the phase are now in second the countries transition Most to have proved solutions some However, that clear also is it 100 10 20 30 40 50 60 70 80 90 0 EBRD Secured Transactions Assessment 2014. Assessment Transactions Secured EBRD 49 Scope, creation and registration – that is to say, they involve the pledging of business business of say, to is involve pledging –that the they 59 Efficiency of secured transaction regimes regimes transaction secured of Efficiency SEMED andTurkey Movable collateral 78 27 Enforcement 52 Central Asia 72 69 Scope, creation and registration CEE, EEC,SEEandRussia 67 Immovable collateral 79 44 Enforcement 55 62 47

Mediterranean (SEMED) and Turkey. Chart A.2.1.1 shows how and capital expenditure, for example) or specific sectoral needs these groups of countries compare in terms of the legal efficiency (in the case of agribusiness, for instance). This is true of all of their secured transaction regimes. three groups of countries, whether it involves supporting the In contrast with the other countries examined, legal development of pre-harvest financing instruments in Russia, frameworks governing collateralisation have been in place in revising the post-harvest financing system (that is to say, grain SEMED countries and Turkey since the beginning of the 20th warehouse financing) in Turkey or improving conditions for leasing century without interruption. However, these systems have not services in Georgia or Mongolia. changed with the shifting business and economic landscape and The next few paragraphs look at local legislative initiatives are currently perceived to be highly inefficient. Land and buildings aimed at facilitating the financing of particular sectors or are often not registered or the relevant property rights are unclear introducing innovative instruments spanning the entire or subject to complex and overlapping sets of rules, and none of financial system. the SEMED countries or Turkey has a modern all-encompassing law governing the provision of non-possessory security over Innovations in agricultural finance movable property. Such a system would allow parties to establish Farmers in transition countries often have difficulty obtaining security interests in respect of any type of movable property by financing owing to their inability to provide creditors with simply registering a collateral agreement or adding a note in a acceptable collateral. Most common types of collateral, such central online register. Since certain frameworks have historic as land or machinery, cannot normally be used for short- significance, it seems that decision-makers in these countries are term finance. At the pre-harvest stage, this makes it difficult faced with a choice between undertaking a general overhaul of for farmers to secure affordable financing, exposing them to the system and amending or fine-tuning the existing frameworks. expensive and usually uncompetitive financing schemes offered These decisions will have to be made on a case-by-case basis. by input suppliers or forcing them to make difficult choices as In this context, it is worth mentioning that Morocco has decided to what investment they can afford. Thus, insufficient liquidity to carry out a general overhaul of its secured transaction system. causes under-investment in the agricultural sector, leading to Reviewing secured transaction systems and supporting other lower levels of productivity and profit (as a result, for example, financing instruments (such as factoring) should be considered a of a lack of high-quality inputs fostering productivity). At the post- priority for this group of countries. harvest stage, only a robust public warehousing system Most of the countries in the first group now have modern for harvested crops would allow farmers to use stored crops central mortgage and pledge registries operating at a as collateral. satisfactory level from a user’s perspective. This means that Various countries have been exploring ways of overcoming financial institutions and investors have a public data source to these problems. One such initiative involves an innovative pre- rely on when making business decisions. By way of example, harvest instrument colloquially called “crop receipts”, which 16 of the 23 countries in this group offer direct or indirect online originated in Brazil and encourages the commercial financing access to their land registries, with 14 countries doing so for of agricultural activities by the private sector. It currently pledge registries. The areas where countries differ most – and supports financing operations with a total value of approximately where major efforts should be made in the future – concern US$ 20 billion a year. specific sophisticated products or transactions. These include A crop receipt system, which is structured around a dedicated the ability to use collateral managers in syndicated lending, the law, establishes a standardised obligation to supply agricultural pledging of bank accounts, the provision of security in respect products or make future payments (to the holder of the receipt) of accounts receivable (in particular, the requirement that all in return for pre-harvest finance (either monetary or a payment accounts receivable be specifically identified at the time of in kind). This obligation cannot be altered or revoked under any the creation of the security, which makes it impractical) and circumstances (including force majeure) and can be incorporated the extension of mortgage rights to cover developments in in a tradeable paper, further increasing its market value. The construction projects. obligation is also secured by collateral, particularly in the form of future agricultural products. Serbia and Ukraine have recently been working on introducing Second phase of the legal development process crop receipt systems. A fully functional national system has been In contrast with the first stage of the legal transition process, introduced in Serbia and a regional system has been developed where the legal landscape for secured credit and other financial in the Poltava region of Ukraine as a pilot for a national system. instruments was relatively uncharted territory, markets now Under this pilot programme, crop receipts with a total value require the improvement of existing systems, taking account of of around UAH 19 million were issued in the Poltava region in lessons learned from the financial crisis and general drafting or the first half of 2015. The two countries’ authorities needed to implementation flaws that have come to light through the use of ensure that the relevant legislation was drafted in a way that existing instruments. There is also a need for the introduction reflected international best practices but also corresponded and/or development of sophisticated legal instruments meeting well to the idiosyncrasies of the local legal systems. All major various financial needs (as regards working capital, investment stakeholders (that is to say, banks, insurance companies and receipt systems. warehouse and in crop trust undermine could which changes, policy and interventions arbitrary of risk the reduce to help should This stakeholders. major among key of issues awareness raising at dialogue aimed bypolicy complemented be to needs technology required of the regulations implementation and the laws and effective of passing The region. the in finance to access systems. receipt warehouse of implementation the –have towards all moved Serbia and Russia recently, –and, more Republic Slovak the and Poland, Lithuania, Moldova, Romania Bulgaria, Kazakhstan, 2010 Since warehouses. bylicensed behaviour negligent or fraud any losses, cover to instance) for fund, an of indemnity form (in the system guarantee aperformance be to needs also There them. issued equally, of which warehouse regardless receipts all warehouse treat to participants enables which regular basis, a on inspected properly be to need and minimum standards certain meet must warehouses licensed The warehouses. for the insurance and inspection licensing, adequate well as as receipts, of warehouse the and and provide registration for issuance the all of parties obligations and rights the out set clearly also should It crops. the for court) of out (typically enforcement easy quick and for providing and instrument the establishing framework legal financingspecific a requires Warehouse receipt harvest. the after prices commodity in agricultural volatility against hedging for markets). Ukrainian and Serbian the to tailored mechanisms enforcement and financing specific to relating obligations and rights (for example, parties contracting the of obligations and rights special and security) non-possessory of aform as products agricultural (using claims future creditors’ of settlement the agreements, such of registration the as as well contracts, financing harvest pre- agricultural governs legislation This solutions. certain of development the for point astarting as served which legislation, the of the drafting during input firms)provided agribusiness procured via leasing arrangements or already being used to to used being already or arrangements leasing via procured being often available (with for long-term collateralisation assets have assets rarely they as guarantees required the provide to III. in Basel provisions liquidity and capital the as such regulations, new of anumber with have comply to they as guarantees substantial now require Banks chain. supply in the circle a vicious creating receivable, of accounts payment late the in turn, exacerbated has, This credit. bank via capital working of availability the limited severely have stringent) more requirements (which capital have made responses regulatory resulting the and crises banking Recent world. the around businesses facing issues pressing most the of one is cycles regular business finance to needed capital working the Securing costs. operating other pay and obligations tax fulfil materials, raw and stock purchase wages, staff pay to used being businesses, for vital is Cash receivables byselling capital working Financing 48 However, more still needs to be done to improve farmers’ improve to farmers’ done be to However, needs still more particularly instrument, useful are another Warehouse receipts Small and medium-sized enterprises (SMEs) find it difficult (SMEs)it difficult find enterprises medium-sized and Small FINANCE REBALANCING 2015-16 TRANSITION REPORT

factoring technically impossible (for example, if the assignment assignment the if (for example, impossible technically factoring make could it as factoring of development impair the to potential the has issues these to solutions appropriate of lack The addressing. are worth that challenges regulatory and tax additional of anumber are also There assignment. electronic of effectiveness the and receivables future assigning of possibility the clauses, assignment on aban of factoring on impact the assigner, the of insolvency the of event in the factoring operations. factoring with associated risk systemic of lowlevels the avoid over-regulation, reflecting also but industry the of legitimacy and stability the ensure to and improving transactions factoring regulation. Such work needs surrounding certainty legal the byincreasing services factoring of development the encourage to rules reliable and clear introducing involves frameworks well). Work legal as on countries transition in other announced being Tunisia and Serbia projects (with Montenegro, in Croatia, regulation of on factoring the projects including area, in this conducted have been projects transition Several years. of couple last the in intensified has industry transactions. of factoring uncertainty legal the reduce and in efficiency the order to increase attention legislative special require These prominent. more have become issues legal certain in EBRD’s the of operations, has increased countries of factoring use the As security). appropriate of lack the and information of finance SME (namely,asymmetry the with associated problems SME’s and is major thus customers insulated usual fromthe relevant the of say, to is riskiness) (that the creditworthiness the on based usually is pricing Its capital. working to access sheet) SMEs giving (off-balance tool financing auseful –is receivable A.2.1.2). Chart see countries; in transition increasing been steadily has which factoring, as (such methods financing alternative for need the increased has this of loans). bank All existing secure CHAPTER 2: SMALL BUSINESSES AND THE CREDIT CRUNCH Source: Factoring volumes in euro millions A.2.1.2. CHART 1,000 1,500 2,000 2,500 3,000 3,500 4,000 500 Typical legal issues include the treatment of recourse recourse of treatment the include issues Typical legal underpinning of legal the structures factoring the Exploration accounts of sale the on based service –afinancial Factoring 0 Factors Chain International Annual Review 2014 and Eurostat. Eurostat. 2014 and Review Annual International Chain Factors

2007 Bulgaria Factoring volumesasapercentageofGDP(right-handaxis)

Factoring volumesineuromillions(left-handaxis) 2008 2009 2010 2011 2012

2013 countries selected in volumes Factoring

2007

Croatia 2008 2009 2010 2011 2012 2013

2007 Hungary 2008 2009 2010 2011 2012 2013

2007 Romania 2008 2009 2010 2011 2012 2013

2007

Serbia 2008 2009 2010 2011 2012 2013

2007 Slovenia 2008

2009 2010

2011 2012 2013

0 1 2 3 4 5 6 7 8

Factoring volumes as a percentage of GDP of percentage a as volumes Factoring 49

the transfer of risk. Following objections raised by market TABLE A.2.1.1. Loans versus leasing participants, with the support of international organisations, the Bank loan Financial leasing Mongolian government launched a legislative reform in 2015 in cooperation with market participants with the aim of amending Customer chooses asset Customer chooses asset the legislation and resolving these issues. Customer repays asset cost plus interest Customer repays asset cost plus interest A similar project – albeit in a slightly different area – has

Loan may be repaid early Lease may be repaid early recently been concluded in Serbia. The country’s Law on Mortgages, which was adopted in 2005, sought to establish a Collateral recovered in event of default Asset repossessed in event of default legal framework for mortgages on the basis of international best Complicated process Simple process practices. The law introduced several new features, including an increase in the number of different types of object that Extensive contract Simple contract could be mortgaged, the creation of a fast-track out-of-court Slower decision on risk Faster decision on risk enforcement procedure and the establishment of a central mortgage registry. However, by 2013, after eight years of practice, Customer has ownership rights Customer has usage rights the law had proved to have a number of weaknesses. These Source: EBRD. ambiguities made it possible for mortgage debtors to obstruct the enforcement of their creditors’ rights, which reduced lenders’ confidence in the system and increased transaction costs. The Association of Serbian Banks had been arguing for a reform of of a future claim is not allowed), prevent the development of that mortgage legislation since 2009 but without any success. factoring companies (for example, if there is a lack of institutional Thanks to vocal support from international financial institutions, support) or raise the cost of factoring transactions on account local banks eventually managed, in 2014, to get the authorities to of the increased legal risks (for example, because courts reform the legislation with a view to tackling the problems which have recategorised transactions owing to a lack of clear had arisen in the implementation of the law. Following extensive legal definitions). negotiations and dialogue with stakeholders, the Serbian Revisiting and fine-tuning established instruments parliament adopted amendments to the Law on Mortgages in June 2015. These amendments will increase the legal certainty In addition to the exploration of innovative new legal instruments, surrounding mortgages and improve the efficiency of out-of-court the second phase of the legal transition process is also enforcement mechanisms. characterised by the revisiting and examination of legal solutions introduced in the past. Recent examples of such initiatives include a review of leasing legislation in Mongolia and the Conclusion refinement of mortgage legislation in Serbia. Legal transition is a continuously evolving process – changing Leasing is a key source of investment finance for SMEs. The and developing (and sometimes even regressing) in line with advantages of leasing for SMEs include: the shifting landscape in local markets. In many transition • the opportunity to conserve cash for other purposes while countries, markets and legislators are now ready to build on the increasing revenues (by acquiring assets without cash systems that have been introduced in the past and focus on more expenditure) sophisticated financial products. It seems that following the initial • potential tax benefits (owing to the depreciation of assets in top-down transposition of basic internationally accepted lending line with outgoing payments) techniques, a more organic bottom-up approach responding to • a reduction in – or absence of – collateral requirements (as the specific needs of particular countries will characterise legal existing company assets do not need to be encumbered) technical assistance in the transition region in the coming years. • the technical support that accompanies leasing services, such as access to maintenance services, spare parts and technical advice (see also Table A.2.1.1).

The concept of financial leasing was introduced into the Mongolian legal system in 2006. However, by 2013, after seven years of practice, certain technical issues had emerged, with References providers of financial leasing services in Mongolia taking the view that the law did not allow the full benefits of leasing to be reaped. J. Armour, A. Menezes, M. Uttamchandani and The efficiency and legal certainty of leasing transactions were K. van Zwieten (2015) being undermined by ambiguous and incomplete drafting (which “How do creditor rights matter for debt finance? did not, for example, facilitate standard sale-and-lease-back A review of empirical evidence”, in F. Dahan transactions and made the repossession process fairly onerous (ed.), Research Handbook on Secured Financing for lessors). The legislation also lacked clear provisions regulating in Commercial Transactions, pp. 3-25.