Who needs credit & who gets credit in Eastern Europe ?

Martin BrownSwiss National Bank & Tilburg University

Steven OngenaTilburg University & CEPR

Alexander PopovEuropean Central Bank

Pinar YesinSwiss National Bank

16th Dubrovnik Economic Conference

Disclaimer

Any views expressed are only those of the authors and should not be attributed to

the European Central Bank, the Eurosystem, or the Swiss National Bank

Paper is under review at Economic Policy (CEPR)

• We have currently (many) new results, but I cannot show them because of the contract with this journal– Past their Panel (Madrid), the journal doesn’t want any new article

results to appear elsewhere

• You will have to read the paper in Economic Policy– But I will provide a sneak preview at the end …

Motivation

EBRD Annual report 2008

Small enterprise finance promotion

• EU / EBRD SME finance facility channelled 1.2 billion euro through local banks to transition countries in 2008

• World Bank / IFC spent 310 million US$ on SME finance projects in 2008

Research questions

1. Which firms are credit constrained in transition countries?

2. Are credit constrained firms typically denied credit or discouraged from applying for credit ?

3. How is credit discouragement / denial related to the structure of the banking sector and the macroeconomic environment ?

Contribution to the literature

• Identifying credit constraints among small firmsCole, JBF 1998Chakravarty & Xiang, 2009

• Financial sector development in Eastern EuropeGiannetti & Ongena, RoF 2008Brown, Jappelli & Pagano, JFI 2009

Firm-level data

• World Bank & EBRD survey: BEEPS– representative survey of firms from 26 transition economies– 1999, 2002, 2004, 2005, 2008

• Data we use: – 5,040 firms from 15 Eastern European countries (BEEPS 2005)– 3,347 firms from 5 Western European countries (BEEPS 2004)

Share of firms with a loan (BEEPS 2004/2005)

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Identifying credit constraints

Dependent variables

• Credit demand: Need loan= 0 if firm did not need loan= 1 otherwise

• Credit discouragement: Discouraged= 1 if needed loan and did not apply= 0 if needed loan and did apply

• Credit denial: Rejected= 1 if applied and does not have loan= 0 if applied and has a loan

Explanatory variables

• Firm-characteristics (BEEPS)– Internal financing, ownership– Exporter, industry– Size, age, financial transparency

• Firm assessment of business environment (BEEPS)– Competitors– Taxation, Licensing & permits, corruption

• Country-level determinants (EBRD, Doing Business, IMF)– Foreign banks, credit info, creditor rights– Inflation

Credit demand (Table 4)

Eastern Europe Western Europe E vs. WSmall Firm -0.043** -0.110*** **Age 0.019* 0.032**Owner foreign -0.122*** -0.212***Exporter 0.064** 0.044Audited 0.019 -0.028Internal finance -0.003*** -0.005*** **Method Probit Probit OLSPseudo R2 0.10 0.21 0.18Country effects yes yes yesIndustry effects yes yes yes# firms 4,349 3,025 7,374# countries 15 5 20

Summary of the results

• Similar demand for credit in Eastern & Western Europe– firms with alternative financing channels demand less– small firms demand less!

Credit discouragement (Table 5)

excluded variable: Internal financing

Eastern Europe Western Europe E vs. WSmall Firm 0.129*** 0.040*** ***Age 0.001 -0.015Owner foreign -0.114*** -0.006Exporter -0.017 -0.041***Audited -0.074*** -0.026Mills ratio - Need loan -0.051*** -0.006***Method Probit Probit OLSSelection corrected yes yes yesPseudo R2 0.16 0.12 0.17Country effects yes yes yesIndustry effects yes yes yes# firms 3,031 1,930 4,961# countries 15 5 20

Summary of the results

• Similar demand for credit in Eastern & Western Europe– firms with alternative financing channels demand less– small firms demand less!

• More credit discouragement in Eastern than Western Europe– small, financially opaque firms are especially discouraged

Credit denial (Table 7)

Eastern Europe Western Europe E vs. WSmall Firm 0.025* -0.007Age -0.013*** 0.001Owner foreign 0.027 **Exporter -0.025* 0.021*Audited 0.000 -0.032*** *Mills ratio - Discouraged 0.059*** 0.147**Method Probit Probit OLSSelection corrected yes yes yes

(Pseudo) R2 0.09 0.09 0.05Country effects yes yes yesIndustry effects yes yes yes# firms 2,188 1,610 3,900# countries 15 5 20

excluded variables: Tax, Licencing & permits, Corruption

Predicted denial rates for discouraged firms (Table 8)

Non-discouraged borrowers

Discouraged borrowers T-Test

Rejection rate in % (actual) (predicted)Eastern Europe 7.6% 12.0% ***Western Europe 4.7% 7.7% **

Summary of the results

• Similar demand for credit in Eastern & Western Europe– firms with alternative financing channels demand less– small firms demand less

• More credit discouragement in Eastern than Western Europe– small, financially opaque firms are especially discouraged– discouragement seems related to foreign bank presence

• Credit denial rates are negligible in Eastern & Western Europe

Country determinants of credit constraints (Table 9)

Discouraged RejectedInflation 0.003 0.001Foreign banks 0.002*** 0.000Credit info 0.010 -0.003Creditor rights 0.007 0.003Method Probit ProbitSelection corrected yes yes

Pseudo R2 0.14 0.07Firm variables yes yesCountry effects no noIndustry effects yes yes# firms 4,961 3,900# countries 20 20

Dependent variable

Eastern & Western European samples pooled

Summary of the results

• Similar demand for credit in Eastern & Western Europe– firms with alternative financing channels demand less– small firms demand less

• More credit discouragement in Eastern than Western Europe– small, financially opaque firms are especially discouraged– discouragement seems related to foreign bank presence

• Credit denial rates are negligible in Eastern & Western Europe

Policy implications

• Many (small) firms are not credit constrained

• Credit discouragement may be reduced by improving information about lending conditions of (foreign) banks

• Implications of the financial crisis are firm-specific– small firms – export-orientated firms

Sneak preview of new results

• Reasons why firms do not apply for loans differ strongly– In Eastern Europe: a higher fraction of non-applicants discouraged

by high interest rates and tough collateral requirements– In Western Europe: more firms simply do not need loans

• Credit constraints in Eastern Europe softened in recent years– Firms which were discouraged from applying for credit or denied

credit in 2005 were more likely to have a loan in 2008 than to be still be credit constrained

• Credit constraints do affect firm performance in Eastern Europe– Firms which are denied credit or discouraged from applying are

less likely to invest in R&D and introduce new products