Fear of debt could limit efficacy of government support

Entrepreneurs’ aversion to taking on more debt may derail government attempts to prevent a liquidity crisis caused by coronavirus, says professor of finance at ESCP Business School, Michael Troege.

The research paper entitled, ‘Now is not the time to be afraid of debt’. The study shows that in times of economic crisis, entrepreneurs are largely risk-averse and as such are unwilling to access government support in the form of loans even if they desperately need it to maintain their business.

“There’s always this perception that you just need to provide better access to funding and cheaper funding and that’s going to relaunch the economy and the SMEs will start reinvesting. But actually, the recent research shows that there’s a big problem on the demand side for a loan. So even if you provide simple and cheap debt, a lot of SMEs won’t take it,” Troege says.

In the UK, chancellor Rishi Sunak has announced a raft of measures designed to help keep SMEs afloat in what is set to be the worst recession in 300 years. As the lockdown measures ground the UK economy to a halt, Sunak launched the Coronavirus Business Interruption Loan Scheme (CBILS), the Coronavirus Job Retention Scheme (CJRS) and later, the Bounce Back Loan Scheme (BBLS).

But as Troege and Nguyen point out in their paper, CBILS and BBLS help businesses alleviate their current liquidity problems with access to cheap loans at a time when many entrepreneurs’ instinct is to take on what they call “self-rationing” behaviour.

“Almost all of the proposed tools rely on the supply of subsidised or guaranteed debt. This is not only problematic because new debt adds to the already high debt level of many companies, but also because SMEs, in particular, will be reluctant to apply for loans in the first place, even if their companies are in dire need of financing. This type of credit self-rationing has been found to be particularly severe during an economic crisis,” Troege says.

“Governments are trying to alleviate the widespread liquidity problems caused by the COVID-19 crisis by facilitating access to loans and guaranteeing debt. But we found that entrepreneurs’ self-rationing behaviour is likely to become more pronounced, possibly generating large economic problems.”

As a result, Troege believes that the government support schemes created so far will not be as useful as first hoped and that governments across the world, not just in the UK, need to offer support and education to entrepreneurs about the realities of taking on debt before it spirals into a liquidity crisis.

Yesterday, the Financial Times reported that US bank executives have seen “minimal interest” in a $6oobn loan facility designed to help small businesses through the coronavirus crisis, in a way that Troege believes reflects “exactly” what his research predicted.

“There’s no detailed questions [in the research] about why [entrepreneurs and SMEs don’t take on more debt], but the suspicion is that it’s either excessive risk aversion or it’s cultural – religion is always negative towards debt, and that may play a role for some people.

“The point of all of this is that all these credit programs may be much less use than anticipated. And that means that you can get a multiplier effect on the economy because you have a lot of SMEs who are not taking the help that’s being offered, which is then going to slow down the economy.”

Troege argues that the solution to tackling widespread debt aversion is through education. The research shows that debt aversion is “strongly correlated” to the education level of the entrepreneur. The lower the education level, the higher the debt aversion, he says. This could be based in cultural factors or fear of taking on more debt at a time of crisis.

However, Troege suggests banks and accountants need to have a bigger role in advising, educating and advertising on loans.

“Banks so far have this attitude that they award a loan, so they are doing the company a favour. But they should probably be selling loans with more consulting. A company that sells a machine to another company, they do all the calculations for them. They prove to the client that this machine has a positive net present value that’s going to create value that is profitable. But a bank doesn’t do that.

“If they really want to sell loans, I think they should be more proactive and should consult the companies more about how the loan is going to impact the profitability of the company, how it is going to improve growth, but that’s clearly not something they have the capacity to do today,” Troeges adds.