How to Save “Good” SMEs from the Crisis

-By INSME Secretariat


On the 26th of February 2021, during the high-level meeting “How to Save Good SMEs from the Crisis”, INSME President Sergio Arzeni discussed the report published by the Group of Thirty titled “Reviving and Restructuring the Corporate Sector Post-Covid” with: Lucia Cusmano, Senior Economist, SMEs and Entrepreneurship, OECD Paris; Mauro Alfonso, CEO of SIMEST; Giuseppe Tripoli, Unioncamere Secretary General; Maurizio Casasco, President of CONFAPI; Massimo Deandreis, Director of SR-M (Research Centre of Intesa Sanpaolo); Giuseppe Gramigna, World Bank Senior Consultant and Former U.S. SBA (Small Business Adiministration) Chief Economist; Salvatore Zecchini, University of Tor Vergata, former Deputy Secretary General of the OECD; and Paolo Garonna, Secretary General of FEBAF (Italian Banking, Insurance and Finance Federation).

Ms. Lucia Cusmano introduced the discussion with an outlook on OECD countries: “Looking at the numbers there is no doubt: this is a crisis that has hit SMEs and entrepreneurship disproportionately hard. If we look at the OECD countries, we find that 60% of employment is in SMEs. If we focus only on the sectors that have been strongly affected by the crisis (tourism, accommodation, personal services, and transport), the share of employment rises to 65%. If we take countries such as Italy and Greece, where the share of employment in SMEs is already higher (80%), we are talking about 90% of jobs at risk today because of the crisis in SMEs.”

SMEs, she continues, have also been affected in their innovative and creative drive. Start-ups and SMEs with a reactive capacity in Covid’s time have focused on filling gaps in sectors that respond to needs and therefore as a form of employment and not with creative potential or growth prospects.

She highlights how the OECD States’ response to the crisis was aligned: the greatest efforts were concentrated on making up for the loss of SME turnover, intervening with liquidity injections (wage subsidies, postponements, redundancy payments, facilitating access to credit, guarantees, public loans), effectively freezing the situation. Some also intervened with financial instruments (depending on the fiscal room for manoeuvre of the individual countries). In the first phase, she continues, little attention was given to structural changes to facilitate digitisation and diversification of market outlets.

Ms. Cusmano goes on to point out that it is not just a question of which SMEs will receive aid, but also “how” and under what conditions SMEs will be able to benefit from aid and structural interventions in the third phase. In fact, one of the main critical issues identified in the evaluations is precisely the accessibility of aid by SMEs and, above all, how to make it accessible in the shortest possible time and with the lowest transaction cost.

Analysing the instruments introduced so far to limit losses, she noted that these increase the amount of debt owed by companies. She stressed the need to understand how to mobilise alternative financing instruments (equity, growth capital) and how to use recent fintech/big data developments to assess the credit risk and health of SMEs.

Cusmano concludes her introduction by suggesting a course of action: “On the question of dynamism and creative destruction […] and therefore how policymakers can move from a situation of crisis management to one of structural change: linking support for SMEs to investments for greater resilience and competitiveness on the market in the long term and therefore linking aid from now on to investments in digitisation, training, access to new markets.”

Mr. Mauro Alfonso shifted the focus and changed the initial question to “how can good SMEs save us from the crisis?”: we need to decide which of them are worthy of attention and which are not strategically useful for the recovery of our economy.

He goes on to point out that in the EU we have moved to a strongly pro-cyclical banking regulation: “From 2008 onwards, we have witnessed an evolution of banking regulation, especially in the EU, which is strongly pro-cyclical: this means that the rules on lending have become extremely stringent and have in fact contracted lending activities, with a remarkably high focus on risks and capital absorption in the face of lending activities. In this scenario it is a problem, because […] this does not help companies to come out of the crisis, neither the good ones nor the bad ones, rather it risks turning the good ones into bad ones.”

What would be desirable, he continues, and which in part already exists, is a suspension or mitigation of banking regulation in the face of the capital absorption risks of lending by banks to businesses.

As regards the choice of deserving SMEs, starting from the evidence that we are in a phase in which the paradigm of development of the global economic system is changing, Mr. Alfonso suggests trying to understand what the critical success factors are for competing in the new paradigm characterised mainly by two phenomena that are accelerating rapidly, and that the pandemic has further accelerated: ESG sustanability (environment, social & governance) and digitalisation (B2C – B2B).

Let us answer the question: which are the good SMEs? Probably those that are investing, or intend to invest, in these two areas (sustainability and digitisation). This is true for all companies in terms of size, and for SMEs that are certainly more fragile. What we are doing is thinking about what instruments can be used to strengthen SMEs to make them stronger and more competitive by providing them with instruments that strengthen their capacity to intervene in these two areas.” 

He concluded by noting that, regardless of the sector, it is crucial for companies to reformulate their business models, as these will have to be based on sustainability and digitalisation in the coming decades.

Mr. Giuseppe Tripoli described how the situation of crisis caused by the pandemic is unprecedented for two reasons: first, for the measures and interventions that have been taken so far to mitigate the crisis, and second for those that will have to be undertaken in this second phase to facilitate a recovery. The measures taken in the first phase, such as aid and facilities for financing and loans, will lead to Italian SMEs finding themselves in a ‘mountain’ of debt by the second phase. In order to prevent this from happening, he suggested we take into consideration revising the debt: the “primum” should be to live and therefore we must ensure that those who can make it endure until the time to get aid.

He continued by assessing a second problem which arises with regard to the issue of assessing companies. In the second phase it will be necessary to reduce economic aid and target it at those enterprises capable of full recovery. However, he continued, by using the same systems for assessing the creditworthiness and entrepreneurial capacity of enterprises as in 2019 or before covid would lead to a misjudgement of the capacities of enterprises: the economy has undergone and is continuing to undergo profound transformations. The lockdown and the crisis have changed some parameters of sectoral markets, business behaviours. Consequently, tracking should also evolve with new parameters. Nevertheless, he admitted that creating a new banking credit system at this time would create more difficulties, so it is advisable to integrate it with new elements, to assist and accompany it.

Importantly, Tripoli highlights how Italy lacks a support structure dedicated to SMEs: “My first proposal is that to get out of this situation, we need to create the conditions in which the companies that can make it are put in a position to do so. A SBA (Small Business Administration), a support structure in our scenario, we have proposed for the role the chambers of commerce. Because in my opinion, in Italy, the situation of aid to SMEs is such that there are so many interventions, but what is lacking is a unified network. A unitary support and reference network, obviously with variable geometry: if in a region there is already an intervention carried out by a regional agency, duplicating it is useless, but there must be a stable and unitary reference point. Therefore, the network of chambers of commerce is the SBA that does this work of guidance, information and support.”

Furthermore, he points out how many of the economic changes that have taken place over the past year have to do with digitalisation and sustainability. This is another issue that needs to be ‘pushed’ in Italy, as the country lags behind its European partners.

He concluded by sharing the results of a survey on which companies were most resilient to the effects of the crisis and which were growing the most: “They found […] (that) the companies with the most quality human capital were the most able to resist and grow. In the survey, when companies were asked what they would prefer to see among the measures of the NRP (National Recovery and Resilience Plan)proposing a range of financial instruments, the bulk of the responses focused on instruments that would make it possible to acquire quality human resources, make the labour market more flexible and make it easier to acquire skills.”

According to Mr. Maurizio Casasco, a major Italian problem is that the application of measures for SMEs is quite different compared to how they were intended. In Italy, he stated, there is a monopoly of large companies: “There was a publication in which the 20 most important private Italian companies are not only those based abroad but also those based in Italy whose tax burden is below 20%, while SMEs are always at 50/60% taxed. The legislation is always in favour of big companies.”

He suggests we cannot divide companies only based on whether they are successful or not: “There are not just succesful companies or zombie companies, there are also companies that would be succesful, but are currently outside certain parameters, so that if they were helped, they could represent the connective tissue that Italy has, and if that falls apart, everything else will collapse.”

A synergy emerged between Casasco and Tripoli on two issues:

  1. The need for a unified network specifically for SMEs, or even a dedicated ministry;
  1. The importance of qualified human capital in SMEs, both from the point of view of the employee and the entrepreneur.

He stressed the importance of management training to improve, update and retrain entrepreneurs in their activities, to reduce the gap that separates us from other European/US countries. Investing in training, he continued, research-innovation and education, encouraging young entrepreneurs, must be a priority at a time when we are only competitive with digital systems.

He suggests the creation of an innovative ecosystem, in which start-ups and venture capitals can have the same tax advantages in terms of acquisition as large companies and promoting and facilitating accelerators that finance and support the company.

With regard to the idea of entrusting banks with assessing which SMEs to grant ait to, Casasco expressed some doubts: “Expertise on the part of the banks: we were the first to argue in February for what was to be the intervention then also carried out by the ECB. But the banks move with independent interests and evaluation parameters and therefore do not risk, while the entrepreneurs do.” And continued by highlighting that these interests are not aligned with the interests of the state.

He goes on to say that it is highly worrying that in some countries, such as Italy, payments between large and small companies (between private companies) are at 150 days: according to research carried out by the University of Brescia, payments at 60 days compared to those at 120 days would bring 50% more liquidity to SMEs, which would not need supplies and would therefore act as a bank for the large companies. The banking system cannot be the only one in charge of defining what is financeable and what is not.

Casasco concluded by suggesting how the relationship between the financial system and trade associations/agencies could be a key element in the analysis of budgets, where there are entrepreneurs, banks, and universities to define how to help businesses.

On the subject of stopping generalised aid and focusing on healthy companies, Mr. Massimo Deandreis notes that it is not only healthy companies that need to be looked at, but also the sectors and supply chains that have the most prospects: it is urgent to have a sort of strategic priority, a so-called industrial policy. Looking at southern Italy, it appears that most small and medium-sized enterprises are concentrated in five key sectors: automotive, aerospace, fashion and agri-food, and pharmaceuticals, which are now so important. The last important sector in the south of Italy is port logistics. That doesn’t just mean the infrastructure aspect, it means the many industrial service companies that revolve around this world. In these sectors, the key words are sustainability, digitalisation, and human capital.

Talking about the availability of credit, Deandreis does not believe it is the main problem today: “[…] Draghi, in a different context, talking about the state debt, said ‘there is good debt and there is bad debt’, and one has to say that the same parameter also exists for businesses. The good debt is the productive debt, the debt that helps companies grow, evolve and improve that previously mentioned productivity. Bad debt is unproductive debt. So how do we distinguish it from the point of view of strategic investment choices? Well, the world is changing completely: the pandemic has accelerated a whole series of transformations that were perhaps already underway, but which are in any case radical and are destined to change and remain so in the medium to long term. The key point is that we need innovative vision even at SME level. Often the small entrepreneur is focused, has an admirable, incredible knowledge of the sector, of the detail of the technical aspects of his company. But they find it difficult to have a broader vision.”

The banking system, according to Deandreis, has a deep knowledge of the needs and requirements of small and medium-sized enterprises: “[…] Draghi saying, ‘the government should use the banks’ expertise’. I really believe that, as a banking system, we have a deep knowledge of the needs and requirements of the SME system. Perhaps we are also capable of accompanying them to have this vision that requires a slightly broader knowledge and understanding, which is not just that of their segment. Also, from this point of view, there is a total overlap. One of the critical and painful points for the banking system, which was emphasised in the speech by Lucia (Cusmano), is that of non-performing loans, and the risk of a resurgence of bankruptcies and NPLs because of this crisis. Therefore, it is clear that the banking system also has a direct interest, because the more you help companies make the right investments, the more you avoid the insurgence of non-performing loans”.

 One of the critical points for the banking system is that of non-performing loans, and the risk of a resurgence of bankruptcies and NPLs as a result of this crisis. Therefore, it is clear that the banking system also has a direct interest in helping companies to make the right investments, i.e., to make that good debt, to quote Draghi’s words, avoiding, in perspective, that forecast of non-performing loans that the projection of the statistics leads to see.

On the subject of dimensional growth, Deandreis observes that larger or more structured companies resist better, as the crisis has also shown. Growth, however, does not necessarily have to be direct, it can also be indirect: mergers and acquisitions. This way, he continues, can also be viable for SMEs, which can look to companies with which they are already doing business, smaller than themselves. It does not necessarily translate into large operations, as indirect growth can also mean consortia, networks, districts, and supply chains.

He concluded by noting how big business can play a positive role on SMEs, not only by improving payment terms, but by bringing them into supply chains and helping them to grow on quality standards.

Mr. Giuseppe Gramigna, on the subject of what could be the ideal tool to identify SMEs that have sound fundamentals and that need help, notes that in an economy with sufficient firm-level data (such as Italy), identifying existing firms or SMEs with sound fundamentals can be accomplished by analyzing their historical operational and financial data. These analyses can be undertaken by any financial institution, including Banks, that have access to these firm-level data. However, some governments wish to concentrate their interventions on firms or SMEs with expected future fast growth. This specific policy intervention poses a very different challenge that cannot be met by only analyzing historical operational or financial data. More specifically, a firm that will experience future fast growth most likely will, in this future, have a very different operational and financial characteristic. Thus, historical operational or financial data, or any historical information for that matter, has so far been of limited use for identifyin future fast-growing firms. In this environment, this identification challenge may be partially solved by flipping it on its head. Thus, instead of attempting an ex-ante identification of future fast-growth firms, government can utilize current knowledge of existing social needs that are most likely met by activities that have a significant high social benefit. More precisely, these social needs are expected to be met by activities of specific types of firms, and these activities are expected to result in significant positive externalities with respect to these firms. Thus, these positive externalities provide a justification and identification methodology for government intervention in specific economic areas, but not of specific high-growth firms or SMEs. He then continues, offering his perspective on the possible role of banks and governments in the current COVID-19 environment, which offers a rare but challenging opportunity to radically improve the structure of the Post COVID-19 economy.

Agreeing with Deandreis that “banks are able to identify existing companies that are financially well-positioned. he emphasizes that, in the current COVID-19 environment, governments that want to obtain the above-mentioned high social impacts, which will probably be met by innovative companies, must empirically ask the additional question of who has left the market. Are they the inefficient ones? In this situation, banks should be perfectly able and willing to help the now more efficient pool of existing firms or SMEs, even the small fast-growing ones. But if companies with a high-risk appetite have exited, then the existing pool of firms will have a lower and deficient risk preferences, and may provide insufficient number of risk-taking firms for financial investments or government interventions. In this environment, governments will need incentivize the entrants of new firms and the growth of existing firms with higher risk preferences. Likewise, financial institutions will need to increase their risk preferences in order to achieve a sufficiently high return on their investments. Unfortunately, not having the luxury of researching which economic agents (firms or workers) have exited the market, governments will none the less need to undertake a series of interventions: (i) identify and incentivize economic activities with probable high social benefit (i.e. firm activities with high positive externalities) (ii) incentivize banks to increase their risk preferences, (iii) provide further support for risk capital, (iv) provide further support or further incentives for information services, and human capital formation that is required for the development of new production and distribution methods as well as new markets. This is especially important because pandemics change societies and economies more than wars.”

He then offers some insights into the US federal government objectives for intervening in the SME sector, and describes the major functions of the Small Business Administration, by outlining the first paragraph of the Small Business Act of 1953. Gramigna notes how the goals, of preservation and expansion of competition is fundamental not only to the economic well-being, but to the security of the US. The goal of Congress is thus not just to improve employment, but to obtain the much broader policy objectives of national well-being and security. This first paragraph indicates that these final policy objectives cannot be realised unless the actual and potential capacity for small businesses is encouraged and developed. Thus, the goal of the US federal government is to intervene in the market where there is clear failure, with the specific role to help, advise, assist and protect SMEs.

He goes on to emphasise the importance in the US system of the Small Business Administration, highlighting the relevance of some of its functions such as (i) providing funds for mission-driven micro finance companies and to Small Business Investment Companies (SBICs) that are venture capital firms certified by the SBA to be able and willing to provide risk capital to SMEs. In so doing it provides financial assistance to the two-extreme end of the SME Spectrum, those in with the most need and those in best positions for fast growth and innovation. (ii) provide technical assistance to SMEs through its network of Small Business Development Centers (SBDCs) via its collaborative relationships with States and academic institutions, (iii) by serving as the voice of SMEs via its Office of Advocacy, which reviews and advises the Federal Government of the impacts to SMEs of new laws and regulations as well as direct SME relevant research, and via its Office of the National Ombudsman, which provides assistance to SMEs that experience excessive or unfair federal regulatory enforcement actions

He concluded by mentioning the importance of R&D and innovation, referring to both the Small Business Innovation Program (SBIR) and the Small Business Technologic Program (STTR).

Mr. Salvatore Zecchini offers an analysis of Italy’s crisis management approach and its recent development with respect to SMEs: “The Italian government has followed the same course of action as that outlined by Lucia for other countries. There was a first phase of generalized aid to all SMEs to cope with the sizeable revenue losses due to Covid-induced restrictions to economic activities. This was followed by a second phase, when Government support became more selective, aiming at those SMEs that were most severely hit by the economic recession and with a focus on investment and innovation more than filling working capital gaps as in the first phase. Now, Italy is in a third phase in which support is highly selective, focusing on those factors that can be seen as the main driving forces of a durable economic recovery, i.e., entrepreneurship, research and innovation, digitalization, green economy, and infrastructures. In such a context, it is a matter for consideration that the policy instruments adopted so far have led most SMEs to over-indebtedness. In other terms, as a result of generous public credit guarantees on bank loans and ultra-accommodative monetary policy, SMEs have increasingly resorted to raising their financial leverage. The resulting bias in their capital structure has, however, come over and above an already unbalanced starting position. This excess-leverage is not likely to disappear in the near future, one reason being that support to ease lending is continuing, and another reason is that such an imbalance is not yet appearing in the data. If we look at the debt ratio, i.e., the ratio of financial debt to GDP for 2020, we do not yet see that this ratio has reached the peak seen during the 2008-2009 financial crisis. However, as Lucia said and pointed out, this way of supporting SMEs has hidden the problem so far.”

Two elements, according to Zecchini, highlight the presence of non-negligible risks:

  1. Cerved, a major company for enterprise data analysis, estimates a rise in the debt insolvency rate of small firms from 6% to 7.4% this year and for medium-sized firms from 7.7% to 8.6%. Furthermore, the central bank and bank supervisor, Banca d’Italia, on the basis of an econometric model expects a 60% increase in bankruptcies by 2022. 
  2. Available data show that as of the month of February, SMEs have applied for debt moratorium in the amount of € 154 billion in addition to that voluntarily granted by banks (17 billion) and have requested public credit guarantees for 141 billion worth of loans.

As the available evidence shows SMEs’ heightened financial vulnerability, he doubts whether once the current pandemic is overcome, the expected rebound in sales and revenues will be enough to restore more balanced leverage ratios.

As to how to identify which SMEs deserve continuing support, while letting zombie firms to fail, Zecchini recalls that different approaches have been developed, ranging from banks’ scoring models to econometric analyses by Istat, the national statistical agency, and Cerved. While banks could use the same scoring models as those applied in the year 2019, namely before the pandemic crisis, he suggests caution, since as a consequence of the current crisis, as well as of the ongoing industrial revolution, the way of doing business has been radically changing. In fact, the scoring models that were used before are outdated to some extent.

A reliable indicator for identifying the resilience of a firm, according to Zecchini, is to look into its ability to adapt to the new market conditions once the current restrictions are removed. For instance, an indicator could be SMEs’ ability to defend their market share and to compete in a changed market environment, features which, however, are difficult to assess ex-ante.

Speaking of possible solutions, he points out that although in theory the government could continue extending aid until the end of the crisis while gradually withdrawing it, there are drawbacks: it exposes the already shaky public finances to the risk of incurring an increasing burden at a later stage. He then refers to other possibilities. “The other solution, which has also been mentioned in some quarters, is to cancel part of SMEs’ debt or restructure it over long maturities with a grant element, but this too has considerable costs and drawbacks. If we look at it from the point of view of the public creditor, we realize that cancellation means a loss of assets for the public sector against a debt that it has contracted on the financial markets, because our government is a net borrower of money, let’s not forget that. So, cancelling the debt means creating a new imbalance in the financial accounts. For the creditor banks, obviously, the situation is a little different, as they have not given new loans without public guarantees and where there was no public guarantee they have asked for much more collateral than in the past. Moreover, banks have already started to make provisions because there are new accounting rules. At the very moment that they give a loan, they must start setting aside a provision that is commensurate with the estimated probability of default or insolvency at the beginning of the loan. The other alternative, which I see […] is the transformation of a part of the debt into an equity stake, and the government has already taken that route, because it has already funded investment funds created ad hoc, to acquire shareholdings in all companies, from large to medium and small.”

Finally, he concludes by noting that it is an illusion to think that public money can replace private capital. The challenge, in fact, lies in attracting private investors, private capital, to contribute to a durable recovery of SMEs.

Mr. Paolo Garonna began by analysing the transition from one phase of the crisis to the next: “The fact of managing this overly complicated and delicate transition from a phase of generalised emergency support, assistance, and aid to a phase of support for the transition, and therefore favouring good companies and encouraging the transition to a more resilient and sustainable world. This is a very delicate phase, as you know economists have this professional training to see if there are important trade-offs. Clearly, they have started the discussion, because if you stop aid too soon, you risk in some way penalising that grey area of companies that still has a chance but has not yet had a chance to express it. On the other hand, if aid is delayed too long there is a risk that the right moment will become more difficult and perhaps even more costly. So, from this point of view, I must say that the principles are right, and the application of these principles is the government’s art.”

He goes on to remind us who makes the final decisions on whether a company is “good or bad”: “In the end, it is the market that decides. The problem we have, and we all have, from the private sector to the real economy, finance, financial intermediaries, and the regulatory framework of legislation, is to make this market work well, and therefore to correct market failures. These market failures are there because in the transition, for example from green to, let’s say, sustainability, it is clear that there are externalities to be re-internalised by doing so with carbon pricing, or some mechanisms that ensure that prices are the right ones and that serve the market to make the right decisions.”

On the question of how to recapitalise the SME sector, Garonna points out that the difficulty for companies to grow also depends on the lack of capitalisation: if small companies don’t grow there is something wrong. In fact, the ability to grow is linked to various factors, such as effective demand, control, use of venture capital, the relationship between ownership and management, and the type of management. There are also complex problems in growing from a workforce perspective.

According to Garonna, there are also problems relating to supply: from the point of view of financial intermediaries there are major problems of bank-centrism, we cannot achieve everything with credit, we have to move towards equity, private capital and therefore private equity and venture capital, as well as there is the fragmentation of capital markets which is a very strong constraint with respect to access to risk capital. It is necessary to promote investment banking, taking advantage of new products, such as preference shares, which would make it possible to solve the problem of control while favouring equity and the recapitalisation of companies.

We need rules and bodies to ensure the proper functioning of the advisory market, the information market and the transparency market. Particular attention needs to be paid to tail risks: they concern so-called black swans, things that are rare and infrequent, but which nevertheless occur and cause very significant damage. According to Garonna, therefore, it would be necessary to strengthen collaboration, focusing on a partnership between the public and private sectors, which would act as a stimulus to the market, and which would also create a market through the information, transparency and disclosure functions.

Garonna concludes with a reference to Europe: only through a process of integration in Europe can these problems (bank-centrism, underinsurance, capitalisation structure) be addressed. The harmonisation of insolvency rules will be particularly important; there will have to be rules to ensure transparency. 

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