Capital Markets Union – Solution for Small and Medium Enterprises ?

The period after the financial crisis revealed falling or insufficiently developing flows of bank credits to non-financial sector (companies and households). In some way banks fail to fulfill their role of financial intermediaries, choosing rather interbank flows. The reason of this is risk aversion, burden of non performing loans and more stringent capital requirements. As a result, companies, and in particular SMEs  suffer of shortage of funds necessary for recovery

The European initiative of Capital Markets Union launched in the Autumn of 2015 proposes facilitated access to finance through capital markets. It is built on an assumption of engaging households in capital markets, with an advantage of higher returns. Obviously, attracting households requires their trust in this form of investment.

The most accessible instrument proposed to SMEs is so called crowd funding. Other manners of access to capital markets may be outside the reach of SMEs.

Crowdfunding emerged as a manner of rising funds for charities through donation by a big number of people. This manner of gathering funds may is used to provide debt or even equity to companies in need. This funding requires a platform to organize flows from investors to beneficiaries. The platform usually also selects potential beneficiaries.

The problem I wish to discuss in my paper is to what degree crowdfunding is a solution to the scarcity of finance suffered by small and medium enterprises.

It is known that access of SMEs to bank finance is hampered by their high risk in the initial phase of operations and, on top of this, by asymmetry of information and costs of disclosing it.

Do crowdfunding platforms help solving those problems?

I will analyze this problem from the point of view of organization and possibilities of the platforms. In most of European countries they are not regulated and their activity depends on informal rules. They obviously assess the risk of potential recipients of funds. However, due to costs they rely on documents provided by the recipients and their analysis is by the force of things superficial. Thus acceptance depends on the quality of documents, and this on knowledge (financial literacy) and fairness of SMEs. Some of them may be rejected simply due to their insufficient knowledge, others may be accepted knowing how to manipulate data. There is thus a big risk of negative selection, higher than in the case of bank finance, where the possibilities of analysis are much bigger. Additional problem  is that due to liquidity preference of providers of funds SMEs may receive rather debt that equity, thus implying high leverage. While it may be positive from taxation point of view, it would not be a stable financing.

The advantage of crowdfunding is however much better possibility of risk sharing among funds providers, if the organization of the platform requires partitioning (slicing) both of funds invested and of investment projects. 

I will assess the overall outcome of this financial innovation for SMEs, taking into account existing experiences.