For SMEs, coronavirus created a demand and supply shock that squeezes small businesses between falling demand and paying the rent. How can they survive?

Our lives have changed with the coronavirus crisis. But have they changed forever? In this instalment of Does This Change Everything? we try to find out why everybody is talking about the impact on small businesses. Why are they hit especially hard? And what could be done to help?

To find out what coronavirus means for small businesses, we spoke to Anna Fusari, who is the European Investment Bank’s head of division for banks and corporates in the Adriatic Sea region. The reason we’re speaking about small businesses with someone who lends to banks is that the European Investment Bank finances small businesses through local banks. Additionally, Anna has been working hard on the EIB’s response to help SMEs affected by Covid-19.

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Has the coronavirus changed everything for small businesses?

The answer is quite simple: it’s a sudden and dramatic change for SMEs. They are greatly exposed to the negative impact of the ongoing epidemic outbreak.

First of all, they are more labour-intensive than other companies and therefore more exposed to disruption, especially when workforces are in quarantine, as is happening in several countries.

In addition, they have thinner liquidity reserves. They have limited financial alternatives, and they mostly rely on support from local banks. In the majority of cases they lack assets that can be disposed of, or that can be used as collateral for new credit lines.

So clearly all these factors make them more vulnerable and exposed to the so-called liquidity squeeze.

The reason why all our stakeholders are focused on SMEs is linked to their economic role; essentially, they are the backbone of the European real economy. Just to give a few numbers, they account for roughly two-thirds of overall employment, and they contribute more than 55% of the overall value-added in the non-financial business economy. So, clearly, supporting the survival of SMEs is crucial for mitigating the economic systemic impact, but also to sustain employment and to create the conditions needed for future growth, once the pandemic is over.

You mentioned ‘liquidity squeeze’. Can you describe what you mean by that?

It is quite simple; on one hand companies  cannot produce, meaning they cannot sell their own products to their end-markets; however they still have to pay all their fixed costs. They have to pay the rent, the salaries, taxes, and their suppliers as well.

With a combined demand and supply shock, it is hard for SMEs to cope with this crisis.

So the problem is not only that employees cannot come to work, cannot produce and provide services. There are also other things affecting the business, like the demand side.

Indeed, all the containment measures that have been put in place to limit the spread of the virus are affecting demand. The sectors most affected by the containment measures (tourism, transport, automotive, to name a few) are the ones where demand has significantly slowed down.

So in this highly unusual situation, what kind of help do they need?

The first answer is that SMEs need support now, immediately. Clearly, the easiest way to provide a  response is to offer some immediate relief in terms of liquidity—for example by extending credit holidays and grace periods for capital payments. At the same time it is also crucial to improve their access to new financial support, by providing additional working capital facilities, or liquidity lines such as factoring, and overdraft credit lines.

Essentially, these small businesses now need access to bank loans in a situation, where if a bank were to look at their business, they might not look so healthy to the bank, is that right? Because if they’re not producing at the top of their capacity, and the demand for their products might not be very high right now, they might not qualify for a typical business loan, right?

Indeed, in terms of credit quality, SMEs will face a deterioration of their credit metrics. They will be impacted in terms of profitability, revenue generation, liquidity buffers, which are all key metrics for a standard credit risk assessment.

As, it is difficult to assess if this will be a temporary symmetric shock and how long it will take to recover, it is crucial that banks continue to lend and provide financing support. Otherwise we would observe a sort of a spiraling effect, with an accelerating number of defaults.

To avoid this effect, several member states have put in place ad hoc measures, which foresee holiday periods imposed by law for capital instalments on existing loans, and public guarantees in order to incentivize banks to support SMEs.

In addition to the measures, those member states are taking nationally, how can the European Investment Bank help these businesses?

We need to focus on measures that can be implemented quickly under existing instruments, to be able to provide an immediate response, while in parallel developing also other initiatives such as risk sharing schemes with commercial banks.

Read Does This Change Everything? from the European Investment Bank, the EU bank. Subscribe to the podcast on iTunesAcast and Spotify.