National economy sectors in the bank financing and their profitability

Abstract

After joining the EU, micro, small and medium enterprises came to the focus of attention in Hungary for their grandiose role in both employment and producing added value. Due to their flexibility, creativity and adaptability SMEs find new market opportunities easier. Also, SMEs can find their way and seize appearing opportunities more quickly under rapidly changing, insecure and high-risk circumstances. When analysing the sector, besides the investigation of the external environment, it is also important to focus on internal factors. The success of businesses is not only influenced by their access to financial resources, but also by their internal organisational structure and the standard of their organisational culture. In the present phase of world economy, when transports are delayed, credits are harder to obtain and companies downsize, leaders have to make careful and considerate management and operational decisions. Thus, financial decisions have considerable short and long-term effects on the success of business operation. This research paper aims at a comprehensive study of the present situation of the Hungarian SME sector, some of its financing opportunities, as well as factors that hinder its development. Another purpose of the present writing is to lay the theoretical foundations for questionnaire primary research exploring the financing characteristics of SMEs in Hungary.

Introduction

For the competitiveness of a national economy, it is indispensable to have a well-functioning, efficient financial system that adapts to the actual market, one that incorporates appropriate and high standard financial services (Lentner, 2007; Mester, 2016; Lentner-Kolozsi,2006). In other words, it can be stated that the existence of a well-developed and active banking system is one of the prerequisites of economic growth (Claessens, 2004, 2009). However, the 2008 financial crisis prompted banks to drastically reduce and tighten SME-lending, and this consequential withdrawal of funding further aggravated the situation of the corporate sector (Mester et al., 2016). One of the most important lessons learnt from the 2008 world economic and financial crisis is precisely the existence of a close relationship between the entire banking system and its immediate and macro environment, even in the short term.

The significance of the banking system in lending

Today, we can see it clearly that one of the most essential elements of a country’s competitiveness is the banking system, which should include institutions that are well-capitalised, have active lending policies and adequate profitability and solvency, that is, institutions that provide an efficient allocation of funds (Lentner, 2013). Long-term sustainable bank lending is one of the fundamentals of economic growth. There has been significant improvement in this area in Hungary over the past few years, partly due to the favourable development of market conditions – low level of interest rates –, partly owing to supportive central bank measures, and partly, as a result of predictable governmental action (Balog, 2018).

Considering that more than two thirds of SME-sector funds come from bank loans in Hungary, the decisive role of these institutions in corporate fundraising becomes evident. It is also worth noting that recently there has been a dynamic corporate credit growth – over annual 10 percent – by international comparison as well. This all means that lending is active in Hungarian banks, which is a key to SME-sector development.

The above trend shows that bank lending to SMEs is healthy and strong. Today, it is also clear that banks play a vital role in the financial education of companies, in strengthening financial literacy. More and more domestic financial service-providers take on the responsibility of disseminating basic financial knowledge and improving responsible decision-makers’ financial literacy. The majority of financial institutions have a competent team of financial experts, who help companies in making appropriate financial decisions. This is all the more important as today there is a fierce competition in the market for clients, especially since they no longer feel the effects of the crisis, and the low interest rate environment also triggers intense competition. Adequate levels of professional knowledge and counselling helps banks retain their corporate clients and improve their reputation. In these cases, awareness building takes place in a targeted way, via providing financial information. Taking the above into consideration, we can state that today, compared to the post-2008 crisis period, both willingness to borrow and loan schemes have totally changed – the SME-sector has learnt from the crisis and makes much more prudent credit-related decisions. These days the vast majority of loans is fixed-interest HUF loan conforming to the MNB’s requirements regarding customer-friendly lending (interview with Becsei András). It is important to remember that companies having a high standard of financial literacy also benefit banks, given that they have a higher chance of avoiding poor decision-making, which allows them to repay their obligations to banks as planned.

Bank financing in the Hungarian corporate sector

The huge body of research shows that ever since the political transition small and medium enterprises (SMEs) play an increasing role in Hungarian economy. Despite internal and external problems, their vast majority shows a strong ability to survive. Aside the present special situation, which requires outstanding levels of state intervention for crisis management to strengthen survival and rapid reaction abilities, in the forthcoming period companies need to resume their decisive role.
It requires, firstly, appropriate funding in the SME-sector (the availability of a proper strong and stable monetary system), and, secondly, the existence of a fiscal policy (tax policy) in support of entrepreneurs, which is indispensable for innovation and launching growth (Kovács-Halmosi, 2012).

In Hungary, access to finance primarily means bank loans for SMEs. National authorities has taken several steps to encourage non-bank lending (capital market, development of alternative sources), yet neither the capital costs, nor the entry barriers proved attractive enough to provide companies with a significant alternative room for manoeuvre.

The correlation between lending and economic growth, as well as the relationship between lending and state revenues (in case of supportive tax policies) are also noted in the 2020 June analysis published by the State Audit Office (ÁSZ).
“Alongside the deepening of banking intermediation, non-excessive, wide-ranging, and healthy – with respect to maturity, lending target and currency – lending help achieve larger economic growth.” The analysis recalls MNB calculations, according to which 1 percent corporate credit growth brings 0.2 GDP growth within a year (Fábián-Nagy, 2015).

Credit growth is balanced if it is paralleled by revenue and investment growth, improved productivity. Sustainable lending can help implement investment to support economic growth, which would be unattainable in the lack of adequate funding.
Based on the 2019 December report of the MNB (The Central Bank of Hungary), it is concluded that after the 2009 financial shock, there was a slower-rate but gradual decrease in both SME and corporate credit growth. After the first half of 2013, there was an increase until the second quarter of 2014, then, following a minor half-year curb, there has been sustained growth. In 2016, credit growth reached the 5-10 percent growth band considered sustainable by the MNB, then, in the 2018-2019 period, it stayed in the 10-15 percent band. Several positive changes have taken place in SME financing in the given period, the 2013 introduction of the NHP (Funding for Growth Scheme) constructions by the MNB helped replace bad structure loans with fixed, low-interest, long-maturity loans with better conditions, and also facilitated access to loans for investment and working capital loans. Besides the MNB’s Funding for Growth Scheme, the Széchenyi Hitelprogram, MFB subsidised loans and the Magyar Export-Import Bank Zrt.’s subsidised export credits were also present on the market.

Looking at some performance indicators for SMEs (2020 State Audit Office report), it is easy to see that the better financing conditions boosted both the incentive to invest and the gross value added. Analysing the number of employees, we can see that there is a slight growth, which further improved productivity.

Excessive lending, however, can lead to banks financing plenty of risky and unproductive investments, as well (Méro, 2015). Even before the pandemic, in December 2019, MNB analysts had dealt with the issue of risk considering the annual 10-15% corporate credit growth dynamics (MNB Financial Stability Report, December 2019). In the third quarter of 2019, credit growth for the entire corporate sector reached the annual 15.4%, while for SMEs the annual credit growth was 14.7%. Growth in the corporate sector was mainly caused by single, large borrowings (financing mergers and buyouts). According to the MNB’s conclusions at the time, as regards credit volumes, more favourable sectoral structure and composition developed than what there had been before the crisis.

1. Manufacturing, trade and food service sectors represent an increasingly large share of the growth
2. The role of financing real estate transactions is less relevant
3. The number of heavily indebted (debt volume amounts to more than four times EBITDA) companies also decreased in 2018-ban, however, their share of the entire credit volume increased

Due to the credit moratorium in effect, today it is impossible to assess how crisis-proof the sectoral structure and composition will be. The MNB’s May 2020 Financial Stability Report, however, shows that one third of the existing credit volume is linked to companies operating in vulnerable sectors. Half of the vulnerable sector are in outstanding risk liquidity position or are heavily indebted.

In banking practice, one of the most important elements in making lending decisions is the probability of default, on which the MNB did a credit risk analysis in 2016 (Banai et al., 2016). According to the analysis, the risk of default is reduced not only by higher revenues, capitalisation and profitability on the debtor’s side, but also by longer maturity. Long-term credit, on the demand side of the credit market, means lower instalments; whereas on the supply side it means lower default risk. Looking at the loans taken out through the NHP Fix construction available until 2020, these could only be used for investment (or leasing) purposes; thus, presumably, have long maturity and greater safety.

The above do not refer to NHP Hajrá, introduced at the beginning of the pandemic, in which working capital loans and debt consolidation loans dominate, which help recover liquidity but stimulate incentive to invest to a lesser degree.

Although the banking system is stable today, institutions are not in an easy situation as they need to make lending decisions for an indebted and greatly weakened corporate sector due to the restrictions imposed by the pandemic (Túróczi et al., 2020)
It would be preferable, all the same, if alongside the stable banking system the incentive to invest also persisted. External funding constraints may force companies to postpone or scale down their investment, or RD&I activities, or the lack of funding may lead to acquisition shortfalls, hindering the development of an efficient company size for SMEs (Balog, 2018). By way of financing investment, job creation and innovation, credit growth contributes to economic growth, which in turn leads to an increase in tax revenues, the whitening of the economy in the central budget, states the 2020 State Audit Office report, which investigated the relationship between SME lending and the whitening of the economy.

It is especially significant in connection with recovery from the crisis caused by the pandemic. The economic policy directives and the long-term economic development centred measures concentrate on the above average growth of the Hungarian economy, which is not feasible without stimulating investment. If we look at the aforementioned NHP Hajrá construction, based on data provided by participating credit institutions until 31 December 2020, investment loans or leasing made up 31%, while working capital loans constituted 53% and debt consolidation loans comprised 13% of the 1 473 billion HUF contract portfolios. Given that the main aim of the construction was to stimulate the economy, the low rate of investment loans suggests, firstly, that economic actors have lost their financial strength and require larger amounts of external funds for their operations, and secondly, that actors are more cautious and less likely to consider investment. This should lead to the conclusion that it is necessary to provide other growth schemes. It is no coincidence that the government introduced a vast array of favourable and abundant investment aid schemes. The VINOP (Business Development and Innovation Operational Program) support packages aim at improving corporate competitiveness in the 2021-2027 EU budget cycle. Since almost all the grants require external funding (own contribution, pre-financing, etc.), an increase in bank investment loans is expected anew due to the incentives.

Methods

The database for our correlational study, that is, individual data equivalent to the information in annual reports, came from the Creditreform company database. More precisely, in our analysis of the relationship between exposure to bank financing and profitability, we used balance sheet and statement of financial performance data from companies subject to corporate tax using double-entry book-keeping. As for time interval, the individual data available cover the year 2018 only; however, we do believe that our hypothesis related to the links between the factors could be tested on cross-sectional data, as well.

For the analysis of the links, categorisation of the indicators examined by deciles was needed, as their variance is extremely high. Deciles are special position indicators (quantiles), which partition the data ranked in increasing order into 10 (in this case) equally large subsections using data points. The greatest advantage of using this method is that it is appropriate for analyses sensitive to outliers. Moreover, it can help develop a nearly evenly distributed variable. The decision about the hypothesis was made based on the value of the Phi indicator measuring the strength of association after the analysis detailed above. The Phi coefficient ranges between 0-1, it is suitable for measuring the strength of association between variables on a nominal or ordinal scale expressed in 2×2 or larger contingency tables. Its value is considered significantly larger than zero if p<0.05.

Analysis of the national economy sectors’ exposure to bank financing in the light of profitability

Taking account of the domestic practice of external financing, in other words, the dominance of continental (bank-oriented) financial intermediary system, alongside the capital structure covering all external resources, our study examined the link between the rate of bank loans and return on equity, using the statistical methods detailed above, based on activity type categorisation for the most part. In view of this, the following hypothesis was put forward:
H: There is a significant difference in return of equity (ROE) between companies most exposed to bank financing and well-capitalised companies, and the differences pertain to activity groups.
Exposure to bank financing was defined using the long-term bank loans to total capital ratio. Taking the values measured in the sample into consideration, we regard those businesses well-capitalised that do not take out bank loans at all. Companies whose long-term debt to capitalisation ratio fell between 0.1 and 3.1 were categorised as exposed to bank financing. Ergo, companies with values exceeding 3.2% for this indicator are regarded strongly exposed to bank financing.
We can see (Figure 2.) that the rate of companies with strong exposure, that is, over 3.2%, to bank financing is highest in the agriculture sector. It is almost the double (21%) of the values for industrial companies. This result somewhat contradicts theories about the financing of agricultural businesses, which say that due to sector-specific risks, these companies have less potential to become clients of commercial banks (Lentner, 2016). Therefore, they have further difficulties accessing external financing resources, which explains the obtained results.

Table 2. Relationship strength results
Symmetric Measures
Phi Approximate Significance
Agriculture. Forestry and Fishing 0.269 0.000
Industry 0.198 0.000
Service 0.163 0.000
Total 0.175 0.000

Source: Authors’ own compilation, based on the SPSS output table.

If we look at the ratio of the number of companies belonging to profitability deciles by sector (Table 1.), we can see that in all three sectors and in total, the stronger exposure to bank financing, the higher the rate of companies having a larger ROE is. The relationship between the two variables is statistically justifiable, and is the strongest in agriculture (phi=0.269; p=0.000), while it is weaker in the two sectors and in total (Table 2.).

When looking at the relationship between the two variables by the separate activity groups, we can state that in every case, the relationships are statistically significant but weak, and in a few sectors, the above tendency does not hold true; instead, just the opposite is true (Appendix 50.). Not surprisingly, these sectors are Electricity, gas, steam and air conditioning supply (D), Construction (F) and Human health and social work activities (Q).
In the light of the above results, the following thesis has been formulated:

T: The stronger the exposure to bank financing in a company, the higher is the probability it having a larger return on equity (ROE), except for the Electricity, gas, steam and air conditioning supply (D), Construction (F) and Human health and social work activities (Q) sectors, where there is a reverse relationship.

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VINOP | palyazatok.org

Petronella Gyurcsik
Ph.D. Economist, Szent Istvan University, National Tax and Customs Administration – Head of Department

Karabassov Rassul
Ph.D. Candidate of Sciences in Economics. Associate Professor Acting. Republic of Kazakhstan, S.Seifullin Kazakh Agro Technical University

Imre Túróczi
Ph.D. college associate professor, University of Debrecen

Éva Mester
financial advisor

László Pataki
Ph.D. associate professor, Hungarian University of Agriculture and Life Sciences

Róbert Tóth
Ph.D. Chief Economist, PhD in Economics, Szent Istvan University, Hungarian Chamber of Commerce and Industry