Recessions and small business access to credit: Lessons for Europe from interstate banking deregulation in the US

by Mathias Hoffmann and Iryna Stewen

Vox
February 19, 2012

Few would deny that there is a strong link between the health of a country’s banks and its public finances. With that in mind, this column argues that the banking system can learn from banking deregulation in the US, with knock on effects for Europe’s sovereign debt crisis.

The European sovereign debt crisis is often viewed as a banking crisis in disguise (see, for instance, Mody and Sandri 2011). Policymakers are rightly concerned about the prospect that ever more cautious banks may eventually stop lending to small and medium-sized businesses (or enterprises, known as SMEs). While large firms can tap capital markets directly, SMEs are particularly bank dependent. It would seem that this is true in particular during a recession, when cash flow is low, finance is hard to obtain, and drawing on bank credit lines may be the ultimate way of survival for many small firms.

Given their share of GDP and employment, continued access of small firms to credit markets is also clearly of paramount importance from the point of view of the aggregate economy. One aspect that is commonly overlooked, however, is that SME access to finance is by itself an important element of the risk-sharing mechanisms that alleviates economic asymmetries and ensures the coherence of a monetary union. This column draws on evidence from contemporary economic history – interstate banking deregulation in the US during the 1980s – to argue that overcoming the persistent fragmentation of Europe's banking system could be an important step towards making Europe and the Eurozone more resilient against major aggregate economic downturns in the future.

A well-functioning monetary union relies crucially on mechanisms that help share the fallout of asymmetric business cycle shocks by limiting their impact on consumption and welfare. Such consumption risk–sharing mechanisms may take several forms – labour mobility is one example. Alternatively, integrated capital markets may allow firms and consumers to diversify their portfolios across the member countries of the monetary union, or to borrow from other countries in the case of a recession at home. Finally, fiscal transfer schemes could partly compensate for frictions in capital markets, enabling for some kind of “fiscal smoothing”.

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