Conclusiones KARIMA AIT HAMMOU

Changes in the bank’s capital or balance sheet liquidity might affect cost of funds to borrowers. In order to lend money to businesses, banks need to attract funds (e.g. bank capital, deposit liabilities, or wholesale funds) by paying a return or interest on them. According to the loanable funds theory, banks need to aim to hold deposits for similar lengths of time as the term of loans financed. In order to survive, banks have to cover the interest rates they pay on deposits from interest rates they charge on loans (interest margin). Higher loan prices in turn affect the quantity of funds intermediated by banks.

Hubbard, Kuttner and Palia (2002) investigated the effects of banks’ financial condition on the borrowers’ cost of funds after controlling for borrower risk and information costs. They find that capital-constrained banks charge higher loan rates than well-capitalised banks and that this cost difference is especially associated with borrowers for which ‘information costs’ and ‘incentive problems’ are most important (pp. 561). Their result is also consistent with models that allow banks to charge a risk premium to borrowers facing switching costs in bank-

borrower relationships, as well as models of the bank-lending channel of monetary transmission.

Informational Asymmetries

As noted earlier in section 2.2.2, informational asymmetries are always present in enterprise financing transactions. Entrepreneurs typically possess privileged information on their businesses that cannot be easily accessed—or cannot be accessed at all—by prospective lenders. According to the New Keynesians, this leads to two problems. First, the lender/investor may not be able to differentiate adequately between ‘high quality’ and ‘low quality’ companies and projects. In that case, price variables (i.e. interest rates) may not work well as a screening device, because high interests may lead to an excessively risky portfolio (the ‘adverse selection’ problem). Second, once the lenders/investors have supplied the funding, they may not be able to assess whether the enterprise is utilizing the funds in an appropriate manner (the ‘moral hazard’ problem). To mitigate these problems, bankers may adopt precautionary measures, such as requiring that financing be collateralised. Alternatively, they may simply turn down the request for financing (‘credit rationing’). Informational asymmetries tend to pose more severe problems for SMEs than for larger business. The information that SME can realistically provide to external financiers (in the form of financial accounts, business plans, feasibility studies, etc.) often lacks detail and rigor. This problem is often aggravated by the low level of education of small entrepreneurs, who may not be in the position to adequately articulate their case.

Lenders’ Risk Appetite

Following from Post Keynesian view of lenders behaviour, banks are only willing to lend to borrowers when the risk/return profile of such borrowers are in their favour (Coppola, 2014). Risk appetite is simply the extent to which a lender is willing or inclined to finance a borrower. It is usually measured as positive, negative or neutral. Risk appetite is shaped by a number of factors: history of previous loan performance, risk profile of business sectors being financed, amount of loan security, financial regulations and general economic and financial conditions. The amount and price of credit supplied to a borrower reflect, according to the banks’ experience and its loan performance data, the probability of the borrower not being able to repay the debt. The higher the level of risk, the higher the price must be to cover the

likely loss. Banks are now more risk averse, both due to the credit crunch and because they are required to be compliant with new financial services regulations (e.g. Basel III). These new rules require banks to hold more capital against certain types of assets. For every loan a bank makes, it must set capital aside to cover for unexpected losses. The idea is to ensure the bank remains solvent and depositors are secure, even if that loan becomes impaired. In order to protect depositors from losses and reinforce consumer confidence in the banking sector, all banks around the world are currently holding higher levels of capital than in recent years. There is a cost to holding this capital and, as banks have increased the amount set aside, this cost has risen along with it.

The amount of risk a bank is faced with is also influenced by the level of security offered by the borrower, so that when the value of security falls, such as commercial property values, the risk increases, and vice versa. The Basel III regulatory framework sets the methodology and calculations used to determine the cost associated with the risk of lending. Risk-adjusted loan pricing enables higher-risk but still allows viable businesses to access finance whilst lower- risk and well-managed firms get the benefit of lower-cost funding. Pricing of risk is in the interest of businesses; even more marginal businesses can still get access to finance (BBA, 2011).

Transaction Costs

Besides risk profile considerations, the business of lending to SMEs is associated with several transaction costs (e.g. Zavatta, 2008; Duan, Han and Yang, 2009; Venkatesh and Kumari, 2011). These include: (i) administrative costs (e.g. costs of meeting a business customer, appraising a loan application and conducting due diligence, setting up a facility, monitoring, controlling, and revising that facility, etc); (ii) legal fees (e.g. costs of providing the legal or contract documentation, filing debt claims, etc); and (iii) costs related to the acquisition and dissemination of information (e.g. costs of purchasing a credit profile from a specialized agency and costs of disseminating regular information such as notification of interest rate changes or changes to other lending fees).

While banks may use credit and performance-scoring tools, most lending decisions will also require a judgement to be made by an experienced relationship manager. Due to their size, smaller facilities tend to have a relatively higher transaction cost per pound lent than larger

facilities, and not all of that cost can be recovered through fees. So small facilities tend to bear higher margins, even if the risk is comparable with larger lending.

2.5.2. Financial Institution and Market Structure