SME Debt Finance with Secured Household Pension Funds and Unsecured. Securitized Debt. A Proposal to Finance SMEs in the Eurozone.

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1 SME Debt Finance with Secured Household Pension Funds and Unsecured Securitized Debt A Proposal to Finance SMEs in the Eurozone Lieven De Moor Hogeschool-Universiteit Brussel KU Leuven Association lieven.demoor@hubrussel.be 19/06/2013 The central objective is to channel long-term household funds from short-term saving accounts to long-term funds for SMEs helping to cover the SME financing gap. Banks are unable to adequately finance SMEs due to the increased capital requirements (Basel III) and the increasing maturity mismatch between short-term savings and long-term SME funds. In Europe capital requirements have increased more than in the rest of the world and in Europe SME funding is struggling the most (see ECB survey 1 ). Some countries take initiatives to cover their SME financing gap such as loan guarantees for SMEs to lower capital requirements. Other countries take efforts to create alternatives for SME funding like stimulating pension funds to invest in domestic SMEs (Denmark, Ireland, UK). These are all fragmented initiatives tapping the tight sovereign budgets. 1 (pg 4) 1

2 Given the aging population and longer and more expensive retirements, individual pension plans become more and more important. But for the same reasons and the increased volatility in capital markets, people are increasingly risk averse. We see that households hold a large part of their essentially long-term pension funds on short-term saving accounts or invest in real estate. Short-term saving accounts are inadequate to build up a descent pension fund and real estate investments are illiquid, cumbersome, undiversified and catalyses the threat of a housing bubble which makes it difficult for young households to buy their first house. There is a need for a safe and easy way to build up a long-term household pension fund in coexistence with the national pension pillars such as governmental pension, corporate pension plan and individual fiscal friendly pension plan. Safe should mean 100% secured capital guaranteed by the EU. Easy should mean that household money can simply be transferred from a short-term savings account to an EU Safe Pension Account by a mouse click. The demand side SMEs go to their local bank. Local banks have the know-how and capacity to screen the SMEs business plan. Based on an EU assessment grid the bank accepts or rejects the proposal. If accepted the SME is co-funded by the bank (x%). This partial bank loan can not be securitized which guarantees the long term commitment. The other part is co-funded by an EU fund. The SMEs have to meet stringent transparency criteria and will be monitored by their home bank. The SMEs have the incentive to go for good and transparent projects in order to get access to finance (co-funded by EU) at lower cost and positive reputation effects towards customers and suppliers, for example via an EU label associated with the SME loan. The bank 2

3 has to meet lower capital requirements for the EU co-funded SME loans 2, but is obliged to monitor the SME regularly. The SME may be fined and lose its EU label if it does not meet the transparency criteria. The bank may also be fined and lose its licence to execute EU SME loans, with low capital requirements, if it does not meet its monitoring obligations. SME loan proposals that are rejected for EU co-funding may be entirely funded by the home bank but only with the higher capital requirements and less favourable characteristics for the SME. The supply side Households can easily transfer funds from their short term savings account to their EU Safe Pension Account. These are long-term funds for fixed time periods. Early withdraw is possible but at a cost. It may be possible to get insurance against certain events to cover the early withdrawal costs. To a household this is a long-term savings account, but actually it is a senior CDO 100% secured by the EU. Use of funds SME EU labelled loans/bonds pooled in different investment horizons stringent transparency criteria, initial screening and frequent monitoring by local bank Cash buffer Source of funds EU Safe Pension Deposits from households senior tranche 100% EU guaranteed, only for households, different investment horizons, not tradable Junior tranche for professional investors, not guaranteed, for pension funds, hedge funds, different investment horizons, tradable Retailised junior tranche as ETFs for retail investors, not guaranteed, tradable Conclusions European SMEs will have more access to finance in a uniform way at the EU level, stimulating real European growth, without fragmentation or tapping the sovereign budgets. 2 Now unrated SME require 7% to Tier 1 capital and 1.4% for large rated companies. The lower capital requirements are justified by the quality of the SME proposal, the monitoring by the home bank and the transparency criteria. 3

4 Banks have the opportunity to receive new assets with low capital requirements. Insurance companies may create and sell new insurance products. Governments are satisfied with the extra opportunity for their residents to build up a safe pension plan, without tapping their government budget. Exchanges are satisfied with the new tradable securities (i.e. the junior tranche CDOs and ETFs). Professional investors and retail investors are satisfied with the new tradable securities backed by quality SME loans. No fiscal reforms and no treaty changes are needed. The national fiscal pension incentives stay intact. FAQ How to divide total funds to senior and junior tranche? The principle is maximum safety, not profits, depending on SME default probability, correlations across countries and sectors (macro scenario s, contingencies), loss given default given credit rating. This impacts the probability that senior tranche sustains losses and the ECB comes in. How to set the co-funding ratio? Depends on the ability of banks to co-finance Why ETFs? Non-equity ETFs are popular due to equity being hit hard, the high correlation between equities and the investors seek for diversification. The ETFs are still risky and therefore not appropriate for household pension plans, but nevertheless an interesting investment vehicle for professional pension funds or individual investors. Why SMEs? SMEs are interesting assets for long term investments, like pension funds, because they offer substantial growth opportunities in the long run. They offer also increased diversification opportunities due to their lower correlation. 4

5 What about current alternatives? The EU bond markets are less developed and SMEs rely more on bank loans than in the US. IPOs are too expensive for SMEs and equity platforms for SMEs (London AIM, NASDAQ OMX, Alternext) are not very successful. We see more debt issues than equity issues. Crowdfunding entails severe regulatory difficulties which makes it at best a complementary channel but remains too risky and inappropriate to build up an average household pension. Lieven De Moor 19/06/2013 5