international analysis and commentary

Reducing the Italian credit crunch: low cost solutions

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Five years after the bankruptcy of Lehman Brothers, growth prospects in Italy and in Europe remain weak, with the credit crunch still representing a major challenge for enterprises. However, in light of a changing banking industry and of the public finance constraints, re-opening the faucet of credit to firms seems difficult in the short term.

As a preliminary step, it should be recognized that the problem of obtaining credit is particularly relevant for micro, small and medium enterprises (MSMEs) as well as startups – traditionally, the subjects identified as the engine of economic growth and innovation. Indeed, small firms and new ones suffer more from adverse selection issues and higher interest rates given that they show a weak asset position and a short entrepreneurial track-record (for startups). According to a recent ECB Survey, in Italy MSMEs are negatively influenced by higher leverage (the debt-to-assets ratio) than in other European countries, more difficulties in obtaining funds from banks and the necessity to provide additional collaterals.

Moreover, the credit crunch is particularly strong in some areas of Southern Italy (the so-called Mezzogiorno), where the challenge of obtaining financing is combined with additional social costs due to organized crime and weak institutions. The credit factor in this part of the country becomes crucial also because the economy of the South relies primarily on small companies. From 2012 to 2013, for instance, a reduction of -2.1% (-2.9% for SMEs) was registered in bank loans to Southern firms – a slightly higher figure than in the North of the country (source: SVIMEZ).

The challenge of improving credit access is clearly related to the dynamic of the Italian banking system and its traditional weaknesses in developing stock markets for SMEs. However, investing in mutual guarantee institutions (Confidi) and Microfinance could help to foster Italian economic growth. These are two low-cost strategies with high-impact potential.

Italian Confidi are institutions in which mutual collaterals are provided by the members: usually, SMEs operating in agriculture, services and traditional manufacturing. Currently in Italy there are about 650 Confidi, 62 of which with turnover of more than 75 million euros. More than one third of Italian SMEs are members of Confidi. Almost 50% of Italian Confidi are in the South. Confidi can contribute to reduce the credit crunch in at least three ways.

First, mutual guarantee institutions can keep the cost of credit low due to asymmetric information issues: on the one side, Confidi provide a preliminary screening of debtors, which limits adverse selection problems; on the other side, they create formal and informal incentives among members reducing the possibility of ex-post moral hazard. Second, being spread at a local level Confidi act as information sources, are useful for monitoring local financial markets and therefore are potential and indirect monetary policy instruments. Third, this system of external collaterals relies on various types of institutional relations between private (such as banks and industrial associations) and public (Chamber of Commerce) actors, thus offering a positive model for joint initiatives.

In the near future, the system of Italian Confidi needs to be bolstered and a series of measures need to be introduces to this end. The Fondo Garanzia per le PMI needs to be amplified, recognizing its importance as a double-collateral for guarantees provided by Confidi. The new supervisory mechanism set up by the Bank of Italy will take into account the balance between positive elements, such as favoring the aggregation between Confidi, and negative ones, such as the extra burden arising from new regulations. Moreover, it would be important to create a network of best practices experienced in some regions, so as to give small Confidi the opportunity of sharing activities and strategies.

Modern microfinance is a fairly new tool in the Italian financial system. It is based upon a set of financial instruments (generally, loans below 25,000 euros) targeting particular categories: individuals or groups without personal and real collaterals and with high-risk profiles. According to the European Microfinance Network, in Italy there were 30 organizations specialized in Microfinance in 2010, with more than 4,000 lines of credit. Typically, the beneficiaries of Microfinance loans are women, immigrants and young people interested in starting small or micro firms.

As widely demonstrated by international evidence in developing countries (a famous example is the Graamen Bank in Bangladesh), microcredit favors the access of credit by particular categories of individuals by creating social constraints, non-pecuniary guarantees and flexible contractual structures. Microfinance operates where the traditional banking system is absent, limiting adverse selection and moral hazard issues. In addition, microfinance can serve as a preliminary screening mechanism for startups, to be subsequently used in the ordinary credit system either as collateral or as a starting point for consolidating lending.

Recently, some interesting initiatives have been undertaken in Italy (for instance the project MicrocreditoDonna) for amplifying the diffusion and the knowledge of microfinance. For continuing this pattern, the national institution Ente nazionale per il Microcredito needs more power and financial support. Making microfinance more attractive for banks would contribute to the success of microcredit in Italy. And the creation of a structured platform connecting microfinance activities and job agencies could contribute to reducing the unemployment and inactivity of specific categories like women and young people.

Ultimately, any modern economy will find a new growth path and reduce its unemployment rate if its firms make investments and innovate. The role of credit in this context is crucial. Confidi and microfinance can be a growth booster.