Evaluation Report
Operations Evaluation Department (EV)
Review of the Current Portfolio
Approach for SME Global Loans
Evaluation Report
Review of the Current Portfolio Approach for
SME Global Loans
Prepared by
EIB Operations Evaluation Department (EV)
Campbell Thomson
March 2002
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NOTICE
The EIB has an obligation of confidentiality in relation to the owners,
promoters and operators of the projects referred to in this report.
Neithe r the EIB nor the consultants employed on these studies will
disclose to a third party any information that might result in breach
of that obligation, and the EIB and the consultants will not assume
any obligation to disclose any further information nor to seek consent
from relevant sources to do so.
* * *
Evaluation
TABLE OF CONTENTS
EXECUTIVE SUMMARY
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1. BACKGROUND
1.1. ESSENTIAL F EATURES OF A R EPORTING SYSTEM
1.2. BROADER ISSUES
2. COMPARISON
3. CONCLUSIONS AND RECOMMENDATIONS
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REVIEW OF THE CURRENT PORTFOLIO APPROACH
FOR SME GLOBAL LOANS
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1. INTRODUCTION
2. BACKGROUND
3. REPORTING PROCEDURES : CURRENT MODELS AND ESSENTIAL
FEATURES
3.1. CURRENT MODELS
3.1.1.
List Procedure.
3.1.2.
Simplified Fiche
3.1.3.
Portfolio Approach.
3.2. ESSENTIAL F EATURES
4. INTERNAL DISCUSSIONS
4.1. ISSUES IDENTIFIED:
5. DESK REVIEW
5.1. SELECTION
5.2. ISSUES IDENTIFIED
6. SITE VISITS
6.1. SELECTION
6.2. ISSUES IDENTIFIED
7. REPORTING PROCEDURES : CONSTRAINTS AND IMPLICATIONS
7.1. SECURITY /AUDIT.
7.2. COSTS.
7.3. R ELATIONSHIP/MARKETING.
7.4. USE OF R EPORTED DATA
8. GLOBAL LOAN ISSUES
8.1. VALUE ADDED
8.2 THE F INAL BENEFICIARY .
8.3 INTERMEDIARY .
8.4 TRANSPARENCY .
8.5 NOTIFICATION OF EIB INVOLVEMENT.
8.6 R IGHTS TO V ISIT.
8.7 POLICY ISSUES .
8.7.1.
Subsidy Handling.
8.7.2.
Sector- and Geographic Area-Specific Operations.
8.8 SME GL OPERATIONS .
8.8.1
Selection of FIs.
8.8.2
Design.
9. CONCLUSIONS AND RECOMMENDATIONS
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Executive Summary
1. BACKGROUND
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This report is the response to a Board request for a review of the SME Global Loan (GL) "Portfolio
2
Approach" . It is important to note that it is not a normal EV post-evaluation of the Bank's GL operations,
and this summary concentrates on Bank’s standard Global Loans.
3
The review compares the Portfolio Approach with the alternative, the “List Procedure” , and the results
are shown below. However, it also considers the essential features of a reporting mechanism and key
issues in the design and operation of the Bank’s Global Loans. These are presented first, to provide
background to the subject.
1.1. ESSENTIAL F EATURES OF A R EPORTING S YSTEM
There is only one essential feature: that it provides confirmation that funds have been used for eligible
purposes. A highly desirable feature is that the system shows that the Financial Intermediary (FI) is
always in line with the EIB’s SME lending objectives. Finally, where the onlending to the Final Beneficiary
(FB) forms part of the security arrangements, then the reporting system must be able to identify individual
Final Beneficiaries, what the funds were used for, and that there will be adequate security throughout the
life of the EIB loan.
1.2. BROADER ISSUES
•
•
•
•
•
There are substantial differences in structure and legal framework between the financial sectors of
EU Member States. A toolbox of loan conditions, including allocation reporting procedures, is
needed to allow the Bank to meet the needs of individual FIs and markets.
The EIB funding advantage is approximately 10% of the FI’s margin, with variations in the FI’s
margins due to competition usually being larger. However, the EIB‘s Funding Advantage
encourages FIs to increase the funding available to SMEs.
At the time of the research, there was no evidence of risk pricing by FIs for different SME risk
profiles, but this is expected to change under Basel II.
The Bank’s contracts include the right to visit FBs but this right not been exercised for many years.
Term lending is only one part of an FI’s relationship with SMEs and loan pricing will typically
include a review of the total return from the FB. Equally, GL lending is only one part of the Bank’s
relationship with its FIs, with loan intermediation, guarantees, placing of bonds, etc. playing an
important part.
2. COMPARISON
Portfolio Approach
Positive
•
Aspects
•
•
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2
3
List Procedure
Generally preferred by FIs - with
more participating FIs there would
be greater competition and thus
more value added.
Forces EIB to appraise the FI’s
total SME term lending activity.
Tends to reduce administrative
costs for both the FI and the EIB.
•
•
•
•
High
probability
that
all
allocations will be eligible.
Regular EIB contact with the FI
may strengthen relationships.
Allows individual FBs to be
identified for loan security and
checks on double financing.
EIB Funding Advantage goes
only to EIB subloans.
PV/CA/00/03 – note 00/59
Where Financial Intermediaries (FIs) provide an analysis of their SME term lending portfolio and confirm that the
funds have been used for eligible purposes.
Where FIs supply summary details for every Final Beneficiary (FBs) e.g. name, location, sector, project cost, loan
amount. These are supplied after disbursement by the EIB, and after the FI has approved the loan to the FB.
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2.
COMPARISON (Cont’d)
Portfolio Approach
Negative
Aspects
•
•
•
Comments
•
List Procedure
Less certainty of eligibility
Does not provide basis for
security.
EIB Funding Advantage goes to
the whole SME portfolio, and is
therefore diluted.
•
Alternative security structures
could be based on ring-fenced
portfolios
(Special
Purpose
Vehicles).
•
•
Distorts the FIs normal operating
procedures.
EIB Funding Advantage must go
arbitrarily to some SMEs and not
to others.
Where the FI has a suitably
advanced
IT
system,
the
distortion,
and
hence
the
administrative cost disadvantage
is minimal.
3. CONCLUSIONS AND RECOMMENDATIONS
EU Policy aims to support all enterprises which meet the SME criteria. On that basis, the Portfolio
Approach is in accordance with EU policy objectives and can offer some advantages. However, the
comparison shows that it is not necessarily a universal solution. There are two main caveats on its use.
Firstly, the appraisal and reporting requirements must be designed to maximise confidence that the funds
are being used for eligible purposes. Secondly, security arrangements may be more complicated than for
the List Procedure.
It is therefore recommended that both the List Procedure and the Portfolio Approach be accepted as GL
financing mechanisms, subject to the following:
•
•
•
The selection of FIs and the design of individual GLs should be explicitly based on policy
implementation and value added. Rigorous appraisal, effective monitoring, and full documentation
at all stages should demonstrate that the Bank’s funds are being used to support SMEs.
The Financial Intermediary should supply the Bank, ex-ante and ex-post, with outline details of its
SME term lending portfolio, broken down by sector, size and location of operation.
During appraisal, there should be a full analysis of the structure of the FI’s SME operations and
portfolio. This should be used to determine the loan amount, such that EIB funding will not
represent more than 50% of the eligible project cost of investments being made by eligible FBs.
It is also recommended that:
•
•
•
The Bank should actively promote competition between FIs.
For standard GL’s, the contract clause relating to the right to visit Final Beneficiaries has become
redundant and should be dropped. The Bank should also develop its communications policy with
the SME sector to make it more aware of sources of EIB funding at an early stage.
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Consideration should be given to bringing the EIB definition of SMEs , as accepted by the
European Commission, into line with that of the Bank’s FIs, with turnover as the principal criterion.
•
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Balance Sheet Limit: 75 M.EUR, Employees: 500 Maximum, Ownership: any shareholder with more
than 30% of the equity must also be an SME.
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Review of the Current Portfolio Approach
for SME Global Loans
1. INTRODUCTION
This report is a response to a request by the Board in relation to SME Global Loans “...that a more
detailed review of the Portfolio Approach and the outlook for its implementation be presented to the
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Board. This analysis will be carried out by the Operations Evaluation Unit" .
The two key attributes of global loan allocation reporting should be transparency and value added.
Transparency is important to ensure that appropriate use is being made of EIB funds, while value added
aims at maximising the effectiveness of the funds. However, these attributes are difficult to quantify in
isolation. The evaluation therefore uses the well-established List Procedure (see 3.1.2) as a benchmark.
Desk and in-depth field evaluations also highlighted a number of broader Global Loan (GL) issues which
have been included in the report.
Initially, the review was to have been carried out by external consultants; Terms of Reference were
prepared and requests for tenders were sent to sixteen consulting firms. However, EV and OPSA (now
OSD) considered that none of the submissions were acceptable. The decision was therefore taken that
EV staff would carry out the work, in co-operation with OPSA. The scope of the review was refined and
the tasks to be undertaken were defined as being to:
•
•
•
•
•
Identify the strengths and weaknesses of the "Portfolio Approach” in comparison with the
alternatives i.e. the List Approach;
Assess the implications of the Portfolio Approach for the Bank, its Financial Intermediaries (FIs),
and the Final Beneficiaries (FBs);
Review the Bank's experience of portfolio operations;
Identify the role of the Portfolio Approach in future GL operations, and, if appropriate,
Develop a set of operating and design practices for the Portfolio Approach.
2. BACKGROUND
The generalities of Global Loans will not be repeated here. They can be found in the papers referred to
above. However, some fundamental characteristics of the Global Loan concept are worth re-iterating:
•
•
•
•
•
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The FI is entirely responsible for identifying, appraising, approving and monitoring the FBs and the
use of the funds;
The FI carries the full credit risk under its normal security requirements for the lending to the FB;
The FI must either have a suitably high credit rating or be able to offer a satisfactory guarantee;
The Bank offers maturity matching with the FI’s onlending. It usually also offers a funding
advantage i.e. a slightly lower interest rate than the FI’s marginal cost of funds, which is not
considered a subsidy;
All projects financed via Global loans should be eligible for EIB lending: the object of the GL
mechanism is to allow projects to be financed which are too small for the Bank to finance directly.
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PV/CA/00/03 – Note 00/59
Under the List Procedure, the Bank accepts or declines individual allocations already approved by the
FI.
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Also, to clarify some misconceptions:
•
•
•
•
All projects must meet EIB eligibility rules, but FIs do not have to follow the Bank’s appraisal
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procedures . FIs employ their own project and credit risk appraisal and approval procedures. In
areas such as the environment and procurement, the Bank accepts that FIs within the Member
States operate within adequate legislative and enforcement frameworks.
The EIB makes funds available on market-related terms. However, the market in question is the
long term bond or inter-bank market. In practice, while the EIB's rates may be slightly lower than
the FI’s marginal cost of long-term capital market funds, they will normally be significantly higher
than FI’s average cost of capital due to the availability of low-cost resources from bank deposits.
FI's use their Treasury Departments to fine-tune the Bank's funding to meet the needs of the FB.
In passing on the Funding Advantage, the FI’s Treasury Department has to cope with differences
in term of the loan, type of loan repayment (bullet or amortising), whether the loan is at fixed or
variable interest, and possibly the currency.
For almost all Member State FIs, term lending is only one of a range of business transactions with
their client: overdraft and short term facilities, credit card facilities, insurance brokerage, leasing,
Letters of Credit, Equity, etc. A Medium-Long Term (MLT) loan based on funds provided by the
EIB may only be a small part of that relationship. Similarly, it should be remembered that the
EIB’s GL lending might be only one element of its relationship with an FI. The scope of the
relationship should be seen as a package including loan intermediation, guarantees for direct
operations, placing of bonds, etc.
While the existing Portfolio Approach will be compared with the benchmark of the List Procedure, an
attempt will also be made to identify best practice elements to be used in any future Portfolio Approach
GLs. To do this, the existing practices will be compared with the set of the idealised reporting
characteristics presented below.
3. REPORTING PROCEDURES: CURRENT MODELS AND ESSENTIAL FEATURES
From the previous section, the Global Loan mechanism can be seen to be a delegation of the Bank's
funding approval to a competent third party. However, this delegation is the subject of a number of
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controls, one of which is the allocation reporting mechanism.
3.1. CURRENT M ODELS
In the last decade, the main allocation reporting mechanisms used within the EU have been the “List
Procedure”, the "Simplified Fiche" and the "Portfolio Approach".
3.1.1.
LIST PROCEDURE.
Information on FBs is supplied in the form of a list of allocations. This list contains basic details of each
allocation: name of FB, location, sector, loan amount, project cost, etc. and has to be supplied within a
certain time of the disbursement. The List Procedure therefore offers traceability on the use of specific
funds. If the Bank identifies an ineligible allocation it tells the FI that it is being rejected. The FI will then
normally supply an immediate replacement. Rejection normally takes place after the allocation has been
financed, by the FI. However, FI staff frequently contact the Bank during the selection process to discuss
eligibility and avoid unacceptable projects being put on the list.
3.1.2.
SIMPLIFIED FICHE
Typically, a one-page fiche with summary details of the proposed client and investment, with more details
than the List Approach. It offers the same traceability as the List Procedure but was originally supplied
before the loan was disbursed to the FI (ex-ante) and also before the client’s investment was financed.
However, more recently, fiches have been supplied ex-post. In these cases the mechanism is simply a
more comprehensive form of the List Procedure.
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Procedures that are designed to ensure that all onlending is for projects which meet the Bank’s
standards and which test projects’ technical, economic, commercial, environmental and financial viability.
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“Allocation” is the term used within the Bank for the individual sub-loans to FBs.
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3.1.3.
PORTFOLIO APPROACH.
The concept of the Portfolio Approach is that the Bank is financing a portfolio of SMEs, not a list of
individual SMEs. At appraisal, for each new GL, FIs provide an analysis of their SME term lending
portfolio broken down by sector, size and location of operation. They also have to confirm, ex-post, that
EIB funds have been used for eligible purposes. As a relatively new development, the reporting
requirements specified by the different operational units of the Bank are still quite heterogeneous but
there is a general requirement for the portfolio to be a multiple of the disbursed amount e.g. the volume of
new SME loans should be twice the value of the GL.
3.2. ESSENTIAL F EATURES
By considering the fundamental characteristics from Section 2., a number of essential and desirable
features for an allocation reporting mechanism can be identified:
• The Bank needs to be satisfied that its funds are being used competently to avoid reputational risk
and misallocation of resources. An in-depth examination could be made of each allocation, but
this would defeat the purpose of the GL and none of the above procedures provides enough
information. The practical alternative is to assess the allocations indirectly, by analysing the FIs
procedures at appraisal, plus a degree of trust developed through the working relationship.
• The Bank’s security requirements are independent of the allocation reporting mechanism.
However, if the “satisfactory guarantee” involves an assignment of rights relating to the FB then
individual allocations have to be identified and the Portfolio Approach does not allow this.
Assignment of rights is used in four Member States. In three of these, the assignment relates
exclusively to the lending to the FB;
• The FI has to be able to show that the Bank’s funds were used for eligible investments. As the
Portfolio Approach cannot do this directly, its use has to be conditional on an adequate appraisal of
the FI’s business and on receiving sufficiently detailed information on the portfolio, including
breakdowns by size, sector and location. However, nothing prevents an FI financing any
investment using its own funds.
• If the GL includes subsidies from external bodies, then the operation has to be open to inspection
by bodies such as the European Court of Auditors. The Portfolio Approach does not provide an
audit trail and so cannot be use for GL’s which carry a subsidy;
There is only one essential feature of an allocation reporting mechanism: that it provides confirmation that
funds have been used for eligible purposes. A highly desirable, but not essential, feature is that the
system shows that the Financial Intermediary (FI) is always in line with the EIB’s SME lending objectives.
Finally, where the onlending to the Final Beneficiary (FB) forms part of the security arrangements, then
the reporting system must be able to identify individual Final Beneficiaries, what the funds were used for,
and that there will be adequate security throughout the life of the EIB loan.
4. INTERNAL DISCUSSIONS
As part of the planning and preparation for the site visits, meetings were held with the operational staff
directly involved with the FIs to be visited and with various lending department managers. These
meetings were unstructured, but the opportunity was taken to gain a better understanding of the FI and
the attitudes towards the allocation process.
4.1. ISSUES I DENTIFIED:
•
The depth of understanding by the Loan Officers of the FIs’ operations and strategies was variable.
Some had a solid understanding of the FI's business; others were unaware of issues such as
organisational structure, decision processes, etc. Generally this was because they were either
new to the Bank or to the client. This reinforces the view that the Bank has a problem with
Institutional Memory. This is an issue that EV has raised before but which goes beyond the scope
of this study. The importance of the observation is that client knowledge often lies with longstanding members of staff rather than with the Bank’s systems and documentation.
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•
•
•
Most Loan Officers and Division Chiefs who had implemented the Portfolio Approach felt that the
reduction in traceability was not at the expense of an acceptable level of transparency and was
therefore an acceptable price to pay. Conversely, some staff with long experience of the List
Procedure stressed that it was not a barrier to good relations with their FIs.
Once allocations have been accepted, neither Loan Officers nor Division Chiefs could suggest any
use of the collected data, other than for reporting and presentational purposes.
Monitoring and reviewing allocation lists from FIs absorbs Bank resources: circa six person-years.
Increased use of the Portfolio approach would free those resources to be used for higher value
added activities e.g. improving the appraisal process for GL operations.
5. DESK REVIEW
5.1. SELECTION
The desk review included twenty one different FIs in nine countries. These FIs were selected as being a
representative cross-section of the Bank’s GL operations and not as either examples of best-in-class or
as potential candidates for the portfolio approach. The review itself was based on the central archive
dossiers and the information held in the EIB’s IT system. The dossiers were well structured and should
have included all relevant documentation, but there were many gaps, particularly in the area of allocation
reporting.
5.2. ISSUES I DENTIFIED
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•
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•
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•
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There was only one explicit reference in the archived documents to the passing-on of part of the
EIB funding advantage by the FI to the FB. However, this appears to be due to the gaps noted
above. From discussions with lending staff, it is clear that this subject is raised and discussed in
depth with all FIs – but that it is not necessarily documented.
The repayment mechanism on almost all EIB disbursements to FIs is a single bullet payment at the
end of the term. Loans by FIs to FBs are almost always on an amortising basis.
The Portfolio Approach is being applied to some single signature borrowers and not others. There
was no correlation between the size of the borrower and the allocation procedure, except that in
one country, only large, single signature borrowers are given the option of the Portfolio Approach.
The allocation period of a significant number of GLs has had to be extended. The reasons are
varied and include over-estimated demand and structural changes in the FI’s organisation.
The greater the number of repeat operations with an FI, the lighter the appraisal report. The
actual credit analysis may be unaffected, but complementary information tends to disappear. No
account appears to be taken of the continuous process of change within organisations.
Many FIs are providing List information in electronic form – either directly or on diskette – but
some still use paper. Where the List is provided electronically, it does not appear in the archive
dossier, and there is no record in the dossier of where the electronic data is being held.
Guarantee arrangements are variable but very few require the assignment of rights relating to the
Final Beneficiary.
The archive dossiers for List Procedure FIs do not include any monitoring information on the FI’s
wider SME lending activities.
Some contracts have SME definitions which do not correspond with the EIB approved version.
6. SITE VISITS
6.1. SELECTION
Site visits were made to a total of 8 Intermediaries in 7 countries. The selection was made jointly by
OPSA and EV.
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6.2. ISSUES I DENTIFIED
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At the time of the missions, the EIB funding advantage for FIs was typically 10 - 15 bps, based on
their marginal cost of long term capital market funds. This represents approximately 10% of the
FI’s margins on term lending to SMEs. Most FIs operate with flexible margins to take account of
competitive pressures. This flexibility is usually larger than the Bank’s funding advantage.
Many intermediaries pass on the whole funding advantage, with others passing on a substantial
proportion. The Lending Departments of FIs work with rate tables supplied by their Treasury.
These provide guideline rates which take the funding advantage into account.
FIs working with the List Procedure can clearly show that the Funding Advantage is being passed
on to specific SMEs. In some case, the rate to the client forms part of the reporting to the Bank.
FIs working with the Portfolio Approach can show that the funding advantage is being passed on
to the whole SME client portfolio - while the FI is in receipt of EIB funds.
Large FIs, without suitable IT systems, estimated the cost of providing List information was 3 – 5
bps. However, actual costs do not appear to have been quantified. Five bps might be reasonable
during disbursement, but seems very high if it applies throughout the life of the loan. None of the
small FIs sampled could identify additional costs for one procedure versus the other.
There is no evidence that the EIB funding advantage influences credit decisions and very little
evidence of structured risk pricing by FIs: risk is a hurdle to be cleared, not an attribute to be
priced in an MLT loan. However, this is expected to change as risk analysis procedures and loan
security systems develop to meet the requirements of Basel II. Risk Sharing by the EIB would
make its funds more attractive to FIs but might not encourage them to accept higher levels of risk.
None of the FIs would be happy about the Bank visiting “their” FBs, and only two of the FIs visited
used the availability of EIB funding as a marketing tool. Publicising the availability of EIB
resources has been used to encourage competition between borrowers, to the SME’s advantage.
However, in one case it also created unrealistic price expectations, leading to complaints.
While some FIs would be happy to act as a conduit for interest subsidies, most would not. In
addition, most large FIs would be reluctant to handle specialised GLs, i.e. for specific geographic
areas or sectors, unless the loan was large enough.
Many of the Bank’s smaller FIs have portfolios which are dominated by SMEs and no special
reporting procedures would be needed under a portfolio approach. However, for security
reasons, very few of these FIs are offered the portfolio option.
In some countries, if a "List Procedure" FI wants to lend more than 50% of the project cost to an
FB, it has to set up two separate loans: one on the EIB terms, including the funding advantage,
and a second based on its own terms.
Most FIs see Basel II as a significant business issue, but not one which will present them with
particular problems. Typically, they either already meet the future ratios or have systems in place
which will be accepted as providing an adequate client rating. However, it is predicted that SME
lending may become unattractive to FIs unless ways can be found to minimise its balance sheet
impact. With its SME GL facility, the EIB could play an important role in mitigating this problem by
encouraging FIs to continue their support of the SME sector.
7. REPORTING PROCEDURES: CONSTRAINTS AND IMPLICATIONS
The choice of allocation procedure may be governed by some of the following issues.
7.1. SECURITY/AUDIT.
As stated above, the Portfolio Approach can only be used where the Bank does not need traceability of
its funds for security or audit reasons. For simplicity, therefore, the Portfolio Approach is best suited to
single-signature FIs. However, alternative security arrangements are possible and being developed: see
8.8.2.
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7.2. COSTS.
It is accepted within many parts of the Bank and FIs, that the cost for FIs to provide list information is
higher than for portfolio information. However, none of the FIs visited had actually calculated the cost
differences, and some suggested that their internal reporting systems could provide list information
automatically, without a cost disadvantage. However, the choice of Portfolio Approach or List Procedure
also has an impact on the Bank's administrative costs as shown in 4.1.
7.3. RELATIONSHIP/M ARKETING.
Although FIs already working with the List Approach were usually quite happy with it, the mechanism is
deterring some new FI’s. At present, the Portfolio Approach is only offered to FIs with which the Bank
already has a sound working relationship. However, the flexibility and freedom of the Portfolio Approach
makes it attractive to potential, new FIs which might be deterred by heavier reporting requirements.
Subject to suitable appraisal, the Portfolio Approach might be used as marketing tool to draw in new FI,
so increasing the general level of competition for SME business.
7.4. USE OF R EPORTED DATA
In the past, economic and market data gathered via allocation lists were used by lending staff and project
analysts. This is no longer the case. Unless the Bank is going to make systematic use of allocation data,
and that this use can show a positive Cost:Benefit (value added) relationship, there is no reason to
collate it.
8. GLOBAL LOAN ISSUES
8.1. VALUE ADDED
The Bank’s Global Loan operations generate three types of value added:
Direct External - from the use of the Bank’s funds to create productive assets. This should be the
biggest single element of value added. It is highly unlikely to be influenced by the choice of allocation
reporting mechanism.
Indirect External - is more difficult to measure directly, but can be seen where the use of the Bank funds
creates a demonstrator effect. One example would be if EIB funds encouraged FIs to develop their
overall SME activity. Another would be if the Portfolio Approach were used to increase the number of
FIs; increased competition between FI’s would reduce the FBs cost of borrowing. This form of value
added is important as it leve rages the Bank's resources.
Internal – An example of internal added value is where the contribution from large Global Loans is higher
than from Individual Loans. This additional benefit can be used to cross-subsidise operations which do
not generate enough income to be sustainable, but which may be desirable on economic or value added
grounds. The cost differences between the two mechanisms are small, but the Portfolio Approach may
offer a marginal benefit over the List Approach.
On balance, there will be little difference between the two mechanisms in terms of the creation of added
value. There may be a slight bias in favour of the Portfolio Approach, but this would be difficult to
quantify.
8.2
T HE FINAL B ENEFICIARY.
Funding from the Bank has certain characteristics: term, repayment mechanism, interest rate and
currency. All of these are of interest to the FI but SMEs are primarily interested in only the loan term and
the interest rate. A simple analysis of the cash flow implications of these two variables was carried out as
part of the review. This showed that loan repayment term variations are more important than direct
funding advantages for SMEs’ investment decisions. In general, the role of interest rates, if they are not
highly concessional, will be relatively small in comparison to the impact of other factors influencing the
investment decision, e.g. demand, capacity utilisation. Separate research by EI, using a different
methodology, came to the same conclusion. Interest rates would have to be highly concessional before
their impact was greater than loan repayment term variations. However, it should also be mentioned that
there is an indirect advantage for FBs in the availability of EIB funds; through consolidation of the FIs
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lending activity to SMEs. EIB funds dedicated to SME financing are well tailored resources, supporting
FIs in their lending activity to SMEs which, in many cases, might otherwise be declining.
8.3
INTERMEDIARY.
In terms of modifying behaviour, the Bank’s lending characteristics have the following effects:
•
•
•
•
•
•
Term. The availability of Bank term funding, should allow most intermediaries to increase their term
lending. A lack of term resources is a constraint for most intermediaries.
Repayment Mechanism. Bullet GLs offer approximately twice the funding advantage of an
amortising loan over the same period. (N.B. Most bullet loans offered to FIs have a shorter term
than the amortising alternative.)
Interest Rate. The Bank's funding advantage, while relevant, is less important than client effects,
competition, and risk.
Currency. The availability of a range of currencies has allowed some institutions to take advantage
of short run pricing differentials.
Conditionalities in the Portfolio Approach have been used to encourage increased term lending to
SME's.
Conditionalities in the List Procedure have been used to encourage increased term lending to
particular classes of SMEs e.g. those in assisted areas..
Behaviour modification on the part of Intermediaries is possible because banks work on the margin.
Some of the above characteristics could therefore be used to modify FI behaviour and align it with the
EIB’s objectives.
8.4
T RANSPARENCY.
By identifying individual FBs, the List Procedure provides traceability, and this, in turn, provides an
acceptable level of transparency. The Portfolio approach does not provide traceability, but does this also
mean that it does not offer transparency? The answer lies in the policy origins of SME funding and in the
depth and quality of appraisal and reporting.
“SME” as an eligibility for EIB funding is based on an EU policy which aims to support all enterprises
meeting the SME definition – except those in excluded sectors, etc.. The policy is not aimed at financing
particular SMEs. Therefore, provided the portfolio reporting can satisfy the condition of eligibility, the
mechanism will meet the test of transparency. The current requirement for portfolio breakdown by size,
sector and location arguably goes beyond the minimum transparency needed. Clearly, particular
attention has to be paid at the appraisal stage to identify the proportion of the FIs portfolio which is not
eligible for EIB funds. This has to be taken into account when setting the loan amount and the maximum
rate of disbursement. To a lesser extent, care is also needed during the monitoring phase. However,
provided the FI makes itself transparent to the appraisal team, the Portfolio Approach can be as
transparent as the List Procedure. The difference is that the transparency comes from a special
emphasis on ex-ante analysis, rather than ex-post data collection.
8.5
NOTIFICATION OF EIB INVOLVEMENT.
The rationale for the Bank's contractual requirement for the FI to inform the FB about the source of funds
is not completely clear. Advising FBs at the contract negotiation stage that the funding will partly come
from the EIB is too late to influence their decisions. Clearly, it is highly desirable for potential FBs to be
aware of the existence and sources of EIB funding. This can lead to competition which reduces costs to
the SME, as well as the SME benefiting from the funding advantage. This argues that the Bank should
allocate resources to actively informing the SME sector about funding availability, rather than mentioning
it in the individual contract.
8.6
RIGHTS TO VISIT .
All FIs were strongly opposed to the contractual right of the EIB to visit their FB clients, since it interferes
with their client relationship. The Bank has not exercised this right for many years and if an FI is
considered sufficiently trustworthy to handle EIB funds, then site visits are unnecessary and redundant.
A visit by right to an unwilling FB would add little to the knowledge of either the Bank or the FI. A visit to
a willing FB does not need a contract term.
9
8.7
POLICY ISSUES .
A review of the validity of EU policies is beyond the scope of this study. However, the implications of a
number of specific policies have been considered.
8.7.1. SUBSIDY HANDLING.
FIs which had experience of dealing with the Court of Auditors, would be unwilling to repeat the
experience. Subsidies via the GL mechanism should be used with caution, and should not interfere with
the Bank’s relationship with its FIs and the FIs’ relationships with FBs.
8.7.2. SECTOR - AND GEOGRAPHIC AREA-SPECIFIC OPERATIONS.
None of the FIs had a problem with the concept of specialised Global Loans – provided the target market
was big enough to justify such an operation. Small, regional FIs, which have smaller EIB loans anyway,
could cope with geographic limits quite easily. However, unless the sector operation matched the
economic activity in their locality, they would have problems finding enough eligible operations. Targeted
GLs should only be considered where the specific market has enough absorptive capacity and where the
potential FIs have an established client base in the target area or sector.
8.8
SME GL OPERATIONS .
The eligibility criterion “SME” is based on EU policy from the 1990s which was, in turn, based on data
which shows that SMEs offered higher rates of innovation and growth than large companies, particularly
in employment. Employment growth figures from that period clearly show that enterprises with fewer
than 50 employees had higher rates of employment growth than larger enterprises, with the smallest (<10
employees) growing fastest of all. A more complete analysis, including trends towards the end of the
decade will be included in a joint EI/PJ paper to be presented to the Board in the near future.
5
This review specifically relates to MLT funds for SMEs as defined by the EIB . This is accepted by both
the Board and the European Commission (EC), although the EC’s own definition is different, as are those
of many national governments and semi-autonomous regions. The problem is that FIs cannot readily
classify their clients using the EIB definition. Experience shows that they tend to submit allocations from
FBs which are well below the EIB limits. The result is that eligible SME FBs are being excluded, a priori,
from EIB funding.
8.8.1
SELECTION OF FIS.
Subject to appropriate standards of quality and performance, it is in the SMEs’ interest for the Bank to
include as many FIs as possible: it increases the likelihood that the FI will already have their primary
banking relationship, and the increased competition will improve the terms to the SME. On the other
hand, EIB funds are limited and it is necessary either to select specific FIs or to cap the funds available to
each one. As previously noted, some of the Bank’s rationing mechanisms are biased towards reinforcing
the relationship as one of a partnership: complementary rather than competitive. However, this has to be
balanced against the rational allocation of resources for SME GL lending.
From this and the previous sections, it is possible to set up a simple set of guidelines:
•
•
•
Ideally, all SMEs should have a choice of FIs: by a combination of regional and national banks.
The Bank’s appraisal should verify that the FIs are effective at delivering servi ces to SME's.
FIs should always be able to provide a portfolio breakdown, at least in terms of their own segment
definition. The trends in the FI's SME business are more important than individual SME
operations.
5
Balance Sheet Limit: 75 M.EUR, Employees: 500 Maximum, Ownership: any shareholder with more
than 30% of the equity must also be an SME.
10
8.8.2
DESIGN .
Each operation needs to be tailored to the specific needs of the FI and its market. Differences in the
structures of both the market and the financial sector will make it difficult for GLs to be standardised in the
foreseeable future. However, there are areas in which some harmonisation is possible:
•
•
•
•
The amount for SME support should be set by the absorptive capacity of the FI. This key element,
together with the Bank’s exposure limits, is taken into account when determining the FI’s existing
and planned levels of business.
Onlending Term: Historically, there has been a minimum of five years but the average term is
reducing as increasing use is made of medium-term leases. The increasing use of advanced
technologies with shorter life-cycles would suggest that the minimum term might be reduced.
Repayment term to the FI: The value added argument for the term to the FI being significantly
longer than the term of the lending to the FB is that the mismatch is a necessary incentive for the
FI to take on the operation. Whether this is true or not requires an in-depth analysis of FI
behaviour which goes well beyond this study.
Structures: The classic structure of a simple loan to an FI is likely to become less common.
Increasing use will be made of alternative structures e.g. special purpose vehicles/securitisation
structures whereby portfolios are taken off the balance sheet of the Intermediary and removed
from the Bank's exposure calculations. These structures have no direct value added but their use
might enable operations which would not otherwise be acceptable to one or other of the parties.
The impact of Basel II may mean that these structures will be needed to increase, or even simply
to maintain, the level of lending to SMEs.
9. CONCLUSIONS AND RECOMMENDATIONS
A number of primary conclusions may be drawn about the Bank's GL operations:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
The Portfolio Approach has been a welcome addition to the Bank’s product range, and offers a
number of advantages. However, it also has characteristics which prevent it from being a
universal solution. The reporting requirements of individual operations need to be structured to
suit the FI, the financial marketplace, and the legal framework.
While the List Procedure allows the Funding Advantage to be traced to individual FBs, the Portfolio
Approach makes the same volume of Funding Advantage available to a larger number of SMEs.
The Portfolio Approach can demonstrate an acceptable degree of transparency, provided there is
an in-depth ex-ante appraisal followed by suitable monitoring.
There is little difference between the value added of the Portfolio Approach and the List Procedure.
There is scope for improvement in the documentation associated with GL operations.
Where an Intermediary has adopted suitable IT tools, its costs for the List Procedure will be similar
to the Portfolio Approach.
Where the security arrangements require assignment of rights relating to specific FBs, the List
Approach provides the necessary traceability, while the Portfolio Approach does not.
The availability of a term resource at a competitive rate of funding is the principal attraction of the
Bank's funds.
The EIB funding advantage is small relative to the total margin charged by FIs and may not be
significant in SME’s investment decisions.
The variation in margin which FIs accept in order to meet competitive pressures is higher than the
EIB funding advantage. Increasing competition may therefore have a greater impact on loan costs
for SME’s than the EIB Funding Advantage.
FIs rarely price risk. The EIB's funding advantage therefore does not influence credit decisions.
However, increased risk pricing is expected with Basel II.
Most FIs do not price loans on an operation-by-operation basis. The rate for a loan is set in the
context of general competition and the Return on Equity which the client's total business
generates.
The Bank's definition of SME is different to that of the rest of the banking sector.
Specialised GLs, either sector or geography specific - whether reporting was by List or Portfolio –
would only be of interest if the market or pricing advantage were large enough to justify a
dedicated operation. Small, special purpose operations would not be welcomed by the FIs,
particularly if the operations had to be co-ordinated with EU or National programmes.
11
There are also issues which affect the FI relationship, independently of allocation procedures and costs:
• All of the FIs expressed concern about the Bank's rights of access to the FB.
• Some FIs were also reluctant to make the FB aware of the source of the funds.
Finally, there are some issues of a more general nature:
• Risk sharing would be interesting to FIs, without necessarily influencing the credit decision.
• Many FIs are attracted by the possible use of Special Purpose Vehicles (off balance sheet), either
to reduce the Bank's exposure or to modify the Intermediaries' prudential ratios.
• Disparities between the repayment terms of the Financial Intermediary and Final Beneficiary, e.g.
bullet lending for amortising onlending, lending for a much longer term than the onlending, may
have an impact on the Bank’s capital requirement.
It is therefore recommended that both the List Procedure and the Portfolio Approach be accepted as GL
financing mechanisms, subject to the following:
•
•
•
The selection of FIs and the design of individual GLs should be explicitly based on policy
implementation and value added. Rigorous appraisal, effective monitoring, and full documentation
at all stages should demonstrate that the Bank’s funds are being used to support SMEs.
The Financial Intermediary should supply the Bank, ex-ante and ex-post, with outline details of its
SME term lending portfolio, broken down by sector, size and location of operation.
During appraisal, there should be a full analysis of the structure of the FI’s SME operations and
portfolio. This should be used to determine the loan amount, such that EIB funding will not
represent more than 50% of the eligible project cost of investments being made by eligible FBs.
It is also recommended that:
•
•
•
The Bank should actively promote competition between Financial Intermediaries.
For standard GL’s, the contract clause relating to the right to visit Final Beneficiaries has become
redundant and should be dropped. The Bank should also develop its communications policy with
the SME sector to make it more aware of sources of EIB funding at an early stage.
Consideration should be given to bringing the Bank’s definition of SMEs, as accepted by the
European Commission, into line with that of its FIs, with turnover as the principal criterion.
12
THE EUROPEAN INVESTMENT BANK
The European Investment Bank (EIB) is owned by the fifteen European Union (EU) Member States and has
its headquarters in Luxembourg. It supports EU policies on a self-financing basis, raising its resources on the
world’s capital markets for onlending to sound capital investment projects that promote the balanced
development of the European Union.
Set up in 1958 by the Treaty of Rome, the EIB has its own administrative structure and decision-making and
control bodies (Board of Governors - usually the Finance Ministers of the Member Countries - Board of
Directors, Management Committee and Audit Committee).
As a major international borrower, which has always been awarded the highest "AAA" credit rating by the
world's leading rating agencies, the EIB raises large volumes of funds on fine terms. It onlends the proceeds
of its borrowings on a non-profit basis.
The volume of the EIB's operations has grown steadily and the Bank is today one of the largest financing
institutions of its kind in the world. While the bulk of its loans are within the European Union, the Bank has
also been called upon to participate in the implementation of the Union's development aid and cooperation
policies through financing for the benefit of some 120 non-EU countries. It therefore supports:
•
economic growth in the African, Caribbean and Pacific States and the Overseas Countries and
Territories, as well as in the Republic of South Africa;
•
a stronger Euro - Mediterranean partnership;
•
preparations for the accession of the Central and Eastern European Countries and Cyprus;
•
industrial cooperation, including the transfer of technical know-how, with Asia and Latin America.
The EIB began carrying out ex-post evaluations in 1988, mainly for its operations in non-EU Member
Countries. In 1995, the Bank established an Evaluation Unit to cover operations both inside and outside the
Union. Ex-post evaluations take a thematic approach and are intended for publication. To-date the bank has
published:
1.
Performance of a Sample of Nine Sewage Treatment Plants in European Union Member Countries (1996
- available in English, French and German)
2. Evaluation of 10 Operations in the Telecommunications Sector in EU Member States (1998 - available in
English, French and German)
3. Contribution of Large Rail and Road Infrastructure to Regional Development (1998 - available in English,
French and German)
4. Evaluation of Industrial Projects Financed by the European Investment Bank under the Objective of
Regional Development (1998 - available in English, French and German)
5. An Evaluation Study of 17 Water Projects located around the Mediterranean (1999 - available in English,
French, German, Italian and Spanish).
6. The impact of EIB Borrowing Operations on the Integration of New Capital Markets. (1999 – available in
English, French and German).
7. EIB Contribution to Regional Development A synthesis report on the regional development impact of EIB
funding on 17 projects in Portugal and Italy (2001 – available in English, French, German, Italian and
Portuguese).
8. Evaluation of the risk capital operations carried out by the EIB in four ACP countries 1989-1999 (2001 available in English, French and German)
9. EIB financing of energy projects in the European Union and Central and Eastern Europe (2001- available
in English, French and German)
10. Review of the Current Portfolio Approach for SME Global Loans (2002 - available in English, French and
German)
These reports are available from:
Operations Evaluation
Fax: (+352) 4379-3494
e-mail: EValuation@eib.org
Den Europæiske Investeringsbank
Europäische Investitionsbank
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European Investment Bank
Banco Europeo de Inversiones
Banque européenne d’investissement
Banca europea per gli investimenti
Europese Investeringsbank
Banco Europeu de Investimento
Euroopan investointipankki
Europeiska investeringsbanken