Bank lending to SMEs and the business cycle in South Africa after the global financial crisis
The global financial crisis that was precipitated in the late 2000s paved the way for several years of economic restraint, and in some cases triggered recessions, in various parts of the world. Economic downturns place a particularly heavy burden on banks since they find it more difficult to raise new capital, extend new loans and meet their capital adequacy requirements. When capital is constrained, banks have two options: reduce lending or raise new equity. Most banks prefer to reduce lending as it is less expensive and less complex than raising new equity and is also more palatable to shareholders.
Economic downturns place a particularly heavy burden on banks since they find it more difficult to raise new capital, extend new loans and meet their capital adequacy requirements.
Financial crises: why SMEs feel the heat more than others
Small and medium enterprises (SMEs) are highly dependent on banks for external finance, especially working capital. Yet in the face of a financial crisis they are much more vulnerable than large corporations. This is because banks typically resort to tightening their lending criteria (such as making collateral requirements more onerous), which many SMEs are hard-pressed to meet. SMEs are viewed as relatively risky borrowers. They are also less financially sustainable than large corporations and in the face of a depressed economy their closure rates are higher.
Another area of concern is that during an economic downturn or full-blown crisis, SMEs are disproportionately affected if banks follow a procyclical approach to credit extension. Many international studies have revealed that banks extend more loans to SMEs when economic conditions are buoyant (and banks are more flush with cash) than when economic activity is at a low ebb. Thus, there is a ‘procyclical’ relationship between what is going on in the business cycle and banks’ lending behaviour. A drawback of this approach is that it accentuates the fluctuations in the business cycle and can prolong or deepen recessions when they come along. Not surprisingly, SMEs bear the brunt of these extended negative cycles and associated ‘credit crunches’ more than larger commercial entities.
When capital is constrained, banks have two options: reduce lending or raise new equity. Most banks prefer to reduce lending as it is less expensive and less complex than raising new equity and is also more palatable to shareholders.
Considering that SMEs play a pivotal role in their countries’ economies, their generally precarious position vis-à-vis established financial norms is cause for great concern. In South Africa, it has been estimated that 91% of formal enterprises are SMEs, which contribute between 52% and 57% of GDP and 61% of employment. The figures for most other African countries are similar. It would be a step in the right direction if SMEs enjoyed greater immunity from the vagaries of both the global and local financial environments.
While the financial crisis has generated a great deal of interest internationally in whether and how banks have modified their lending behaviour towards SMEs, relatively little research has been done on how SMEs have been affected in South Africa. Where studies have been conducted, they have largely been of a qualitative nature. The purpose of this study was to investigate bank lending to SMEs during the global financial crisis and whether its response to the business cycle was positive or negative. Vector autoregressive modelling was used, with monthly data sourced from the South African Reserve Bank (SARB) for the period 2008‒2014.
In South Africa, it has been estimated that 91% of formal enterprises are SMEs, which contribute between 52% and 57% of GDP and 61% of employment.
The study not only makes a valuable contribution to the quantitative literature on bank lending to SMEs in South Africa, but the results should also help to inform policies aimed at prioritising lending to SMEs during times of crisis – when a financial lifeline is most urgently needed.
Key finding from the study and the way forward
The study revealed strong evidence of credit procyclicality between the business cycle and bank lending to SMEs in South Africa during the period under review. This finding suggests that many banks reduce their lending during lean times when there is increased risk of non-payment and their capital base shrinks. This could have economy-wide repercussions as SMEs, being the important economic actors that they are, would be cut off from credit which is often needed to sustain their operations and growth.
Banks extend more loans to SMEs when economic conditions are buoyant (and banks are more flush with cash) than when economic activity is at a low ebb. Thus, there is a ‘procyclical’ relationship between what is going on in the business cycle and banks’ lending behaviour.
There is a clear need for the banking sector to make more – not less – credit available to SMEs during significant economic downturns or crises, underpinned by innovative checks and balances to mitigate risk. SMEs would also benefit if they had access to a more diverse range of finance options which could be appropriately tailored to their specific needs – rather than be forced to measure up to a ‘one-size-fits-all’ standard. The introduction of forward-looking, credit-supporting policies would help to accelerate this process.
There is a clear need for the banking sector to make more – not less – credit available to SMEs during significant economic downturns or crises, underpinned by innovative checks and balances to mitigate risk.
- Akinsola, F. & Ikhide, S. (2019). Bank lending to small and medium scale enterprises (SMEs) and business cycle in South Africa after the global financial crisis. The Journal of Developing Areas, 53(1), 79-94. DOI: 10.1353/jda.2019.0005
- Foluso Akinsola is a doctoral graduate of development finance from the University of Stellenbosch Business School.
- Sylvanus Ikhide is a professor of Development Finance from the University of Stellenbosch Business School.