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How would Brexit affect finance for SMEs?

In this new series, an expert panel is answering questions sent in by readers about how the EU referendum could affect their business. This week our panellists take on a question from Peter Shawyer, commercial director at an electronic manufacturing SME Texcel Technology:


One issue that has previously constrained our business is finance. After leaving the EU would financing – from banks, investors or funds – be more restricted or more open?

If you have a question about the impact of the EU referendum, you can submit it here. We will select a question each week for the panel.


Daniel Gros Photograph: Gleamlight

Daniel Gros

Director of the Centre for European Policy Studies. He serves as adviser to the European Parliament and is a member of the advisory scientific committee of the European Systemic Risk Board (ESRB) and the Euro 50 Group of eminent economists

Finance to SMEs – and households – is usually provided by local retail banks. Funds, be it pension funds or hedge funds, do not engage in this type of business because they do not have the necessary local knowledge and the individual loans are too small for them. In this sense there is no reason why leaving the EU would have a material impact on the availability of finance for SMEs.

The EU has some special programmes for SME financing, which would of course no longer be available if the UK leaves the EU. But these programmes, operated via the European Investment Bank (EIB), have not had a large impact on SME lending and the UK government could use the increased financial leeway it would have by cashing in on its EIB capital to institute similar schemes.

Part of the UK’s retail banking system is owned by EU banks. This investment would of course have a different legal status after Brexit, but presumably the change in legal status would not have a direct impact on retail operations, such as lending to SMEs.

However, leaving the EU might have a longer term impact on the availability of financing stemming from the large external, current account deficit the UK has been running for quite some time now. Being a member of the EU makes the UK more creditworthy as can be seen from a recent report by a major credit ratings agency. UK borrowers might therefore have to pay a somewhat higher price for credit and the availability of external financing for the entire UK economy might be reduced, which would translate in a reduced availability of credit for SMEs as well. Most observers agree that the problem is manageable, but a slight negative impact might be unavoidable in the long run.

Sebastian Dullien


Sebastian Dullien Photograph: Jakob Lessin

Sebastian Dullien

Senior policy fellow at the European Council on Foreign Relations and professor of international economics at HTW Berlin, University of Applied Sciences. His research focuses on European integration, international macroeconomics, and financial market regulation

In the short term, a British decision to leave the European Union would create huge uncertainties in financial markets which would translate into more restrictive financing conditions and less availability of funds for small and medium sized enterprises. With a national current account deficit of almost 5% of GDP, Britain depends on foreign investors. Brexit would create huge uncertainties about the future relationship with the EU, so it is very likely that these investors will demand a risk premium, which would be passed on as higher interest rates to SMEs.

In the long term, the outcome depends on which future relationship Britain negotiates with the EU. The most likely result is that the British financial and banking markets become less integrated with that of the EU.

One proclaimed aim of leaving the EU is to re-gain national sovereignty. Setting national rules for the banking industry is incompatible with a single market for financial services. Thus, a British EU exit would make it more difficult for continental banks and investment funds to provide finance to British small and medium sized companies as they would have to follow different rules and regulations and use additional licensing requirements. The result would be less competition and less availability of funds for British SMEs.

However, there might be counteracting domestic forces. In principle, it is possible that the British government would reduce banking regulations which might lead to lower funding costs. After the financial crisis of 2008/9 and the huge fiscal costs related to bank rescues, Britain’s Independent Commission on Banking headed by John Vickers actually proposed stricter rules than were later passed in the EU. It is not clear why the UK government should change course in this area after a Brexit. British retail banking has in the past been repeatedly criticised for extracting excessive fees and interest rates also from small business. If competition in banking dwindles with an exit from the EU, banks might just as well continue to overcharge SMEs even if regulatory rules are relaxed.

Swati Dhingra


Swati Dhingra Photograph: Federico Protano

Swati Dhingra

Assistant professor at the department of economics at the London School of Economics and co-author of Life after Brexit: what are the UK’s options outside the European Union?

One of the four basic freedoms of the EU is free movement of capital, which enables firms to invest in other European companies and to raise money in EU member countries. But the option of raising capital abroad is typically beyond the capacity of most SMEs, who instead rely on banks and government bodies for external finance.

Survey data suggests that European banks have had a limited impact on the terms of bank lending to SMEs, which also have limited ability to tender proposals for funding from the European Commission. So the direct channels for SME financing from the EU are less important, and the question is whether Brexit will impact other avenues for access to finance.

The vast majority of SMEs in the UK export to the EU, and this trend is unlikely to change because selling to distant markets is even more challenging for SMEs. Even if Brexit immediately gives way to a Norway-style trade deal, small business owners will face greater costs when trading with the EU. Currently, SMEs benefit from EU directives, such as the late payment directive, which are important for day-to-day financing. These factors would reduce profitability and make borrowing more difficult for small businesses.

A bigger issue is that economic uncertainty is likely to increase in the run-up to the referendum and in the event of a Brexit. We already saw this with the sterling volatility following Boris Johnson’s announcement supporting Brexit. Greater uncertainty in economic conditions typically hits SMEs harder, as they are perceived to be higher risk. This is what happened during the financial crisis, when banks shifted their lending away from SMEs and towards larger businesses.

While UK SMEs are less reliant on EU funding right now, this could change as the EU scales up its financing programmes. The European Investment Bank plans to lend ₤100m to SMEs in the UK. If this funding dries up after Brexit, domestic sources such as the British Business Bank would need to find the funds to make up for these shortfalls.

Sjoerd Douma


Sjoerd Douma Photograph: Leiden University

Sjoerd Douma

Professor of international and EU tax law at Leiden university

Free movement of capital is a cornerstone of the EU’s internal market. Article 63 of the treaty on the functioning of the European Union (TFEU) states that “all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited”. While the text of this provision seems clear, in practice Europe’s capital markets are still fragmented along national lines.

This is exactly why EU Commissioner Jonathan Hill has launched the initiative for a Capital Markets Union (CMU). According to this action plan, the European Commission will remove the barriers which stand between investors’ money and investment opportunities and overcome the obstacles which prevent businesses from reaching investors. If the UK is no longera part of the EU, these measures will not apply to capital movements between the EU and the UK, subject to article 63 TFEU. This will relatively weaken the position of UK businesses to obtain financing from within the EU as compared to EU businesses.

The European Investment Bank (EIB) estimates that by March 2016, the European Fund for Strategic Investments (EFSI) triggered around €76bn (£61bn) of investment in Europe. If the UK left the EU, access to this fund for financing purposes would be difficult if not impossible.

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