SMEs in the Western Balkans and their financing needs

The number of SMEs in the Balkan region totals more than 800 thousand or equivalent to 40 enterprises for every 1,000 inhabitants. This average density is not far behind the EU average of about 44 enterprises per 1,000 inhabitants. The frequency varies from a low of 25.5 enterprises per 1,000 inhabitants in Kosovo to a high of 48.7 in Bosnia and Herzegovina.

One factor that could at least partly explain the gap between SME density in the Western Balkans and the EU is the high unemployment rate (averaging 24% in the six countries), particularly the unemployment rate among young people (averaging 46%). The unwillingness or inability of the unemployed to start a business is an important constraint to economic development in the region.

The local statistics agencies use the number of 250 employees as the upper boundary for the definition of an SME, except in Albania where the boundary is 50. The statistics for Albania, therefore, effectively represent the number of micro and small enterprises (based on the EU definition) rather than the number of SMEs.

The statistics in all countries exclude unregistered businesses, overlooking what is reported to be a large informal economy. In Serbia and Kosovo, the number includes all registered SMEs, while in the other countries, only the number of active enterprises, those that submitted financial reports in the most recent period are counted.

The number of SMEs as a share of the total number of enterprises is generally consistent throughout the region, varying from 99.7% to 99.9%, in line with the EU average of 99.8%. In Kosovo, Macedonia and Serbia, the contribution of SMEs to total employment is above the EU average of 67%, while it is a bit more in Bosnia and Herzegovina, Albania and Montenegro.

SMEs in Bosnia and Herzegovina, Macedonia, and Montenegro exhibit a contribution to value added which is higher than the EU average, although Serbia’s contribution is below average, mainly because Serbia has a more successful large corporate sector than the other countries.

SMEs tend to be most active in the trade and service sectors and less so in manufacturing and agriculture. The very low share of agricultural enterprises that most small farming households are not registered and thus not included in the official statistics. The trading sector represents from roughly 30% to 50% of all SMEs in the region, above the average of 28% for SMEs in the EU.

Although manufacturing only accounts for 9% to 16% of SMEs, several of the countries analyzed exceed the EU average of 9%, with Serbia and Bosnia and Herzegovina having the highest percentages. In all countries in the target region, the percentage of SMEs engaged in construction is well below the EU average. Most of the other category is accounted for by the service sector.

The Balkan countries tend to have a moderate to high concentration of enterprises in the capital city and surrounding area. In Albania, the concentration around Tirana is especially high at 44%, whereas Kosovo, Montenegro and Serbia have lower concentrations of 24%, 32% and 31%, respectively.

In the World Bank’s Doing Business rankings for 2016, Macedonia ranks very highly, at 12th out of 189 economies, with Albania and Bosnia and Herzegovina ranked relatively poorly. Macedonia’s excellent performance overall is highlighted by a rank of second in the world in terms of starting a business, and the country is also in the top ten for paying taxes and getting construction permits. Across the region, the topics of construction permits, getting electricity, and paying taxes rank poorly on average, whereas getting credit, trading across borders, and protecting investors are ranked highly.

The preference for loan funding is mainly a function of the familiarity of SMEs with loan products and the financial institutions that offer them. Most entrepreneurs are familiar with the content of a loan contract and the average interest rates and maturities which are being offered to similar businesses, so there is less risk that they will be taken advantage of. Furthermore, entrepreneurs generally know which lending institutions are the most reputable, at least based on word of mouth.

By contrast, they usually have less information about leasing companies or private equity firms and less information about the contractual conditions on such products. The fact that loan products and lending institutions tend to be more strictly regulated and supervised than other types of products and institutions may also provide additional incentive for SMEs to prefer loans. In most of the countries, SMEs do not have a strong preference for certain currencies, either because the country has adopted the Euro (Kosovo and Macedonia) or because the central bank has successfully maintained exchange rate stability in recent years. Only Serbia has experienced exchange rate fluctuations (in 2012 and 2014), leading some clients to prefer local currency.

Within the category of trade finance, loans are by far the preferred instrument for SMEs despite the fact that many banks offer unfunded products such as guarantees and letters of credit. When unfunded trade finance products are demanded, it is most commonly guarantees that are requested rather than letters of credit. Demand for equity and quasi-equity from formal institutions is low in the region.

Cultural factors may play a role, as businesspeople may be averse to cooperating with outsiders and sharing a part of their business with strangers. Lack of awareness of the availability of equity products and lack of familiarity with the products themselves (such as a standard term sheet) also negatively affect demand.

Although most countries in the region have at least some venture capital ecosystem in the form of incubators, business centers, academic programs, and others, they tend to be small in scale and not well known among the SME community. This ecosystem could be the best source for providing information to SMEs about equity products and helping build demand.

The level of demand for SME financing has been increasing at a very slow rate in the region over the past five for all types of products. This is in line with slow economic growth and low growth in the total number of SMEs. In the most recent periods, however, particularly in 2015, there has been a notable acceleration in the demand for credit. The EIB’s CESEE Survey of Bank Lending confirms this, with five consecutive semesters of positive results recorded as of the end of 2015.

Loans are the primary financing instrument for SMEs and are widely available in a diverse spectrum of products, including overdrafts, credit lines, credit cards, working capital loans and investment loans, among others. The highest levels of financial intermediation, measured as the ratio of loans to GDP, are seen in Bosnia and Herzegovina and Macedonia, while Albania and Kosovo have the lowest levels. The growth rate of the loan portfolio has been slow in recent years in the region, consistent with slow economic growth and slow growth in the number of SMEs. Only Macedonia has experienced strong loan growth in both 2013 and 2014. Serbia’s loan growth was high in 2014, but this followed a sharp drop in the previous year.

The supply of leases is small in comparison to loans, the outstanding portfolio of loans dwarfs that of leases by many times. In many countries in the region, leasing volumes decreased dramatically from 2009 onwards for the next several years, with the decline in leasing much sharper than the decline in loans. Since most leasing companies were subsidiaries of banks, and most banks considered leasing as a non-core product, the leasing companies were quick to lose support from their parent companies. Leasing companies tend to focus on vehicle financing and engage in a very limited amount of equipment financing. There is not much product variety, with most leases structured as finance leases and relatively few operating leases. Leasing companies generally have small branch networks, making it inconvenient for clients not located near the largest cities. Nevertheless, on average, a large share of the leasing portfolio is disbursed to SMEs, a much larger share than for the loan portfolio.

Equity financing is generally in very limited supply, but the situation varies from country to country. In Montenegro, there are no known venture capital or private equity investments in SMEs by formal institutions, although it is possible there have been a few small investments from angel investors. In Bosnia and Kosovo, the total supply is estimated to be less than EUR 1 million in each country, consisting of just one or two transactions per country. In Serbia, Macedonia and Albania, the total supply of such financing is higher than the other three countries but still at a very low level relative to GDP.

Since a wide variety of strategic options for funding and technical assistance for the countries of Balkan region, it is crucial that they should decide to:

Increase investments designed to mitigate the startup gap and create opportunities for the unemployed (especially young people) to join the ranks of entrepreneurs.

• The best approach to achieve this is through increased investment in guarantee funds to mitigate the risks for banks of working with these customers.
• Increasing the availability of venture capital funding would also be beneficial for innovative and potentially high-growth startups.
• At the same time, greater availability of technical assistance in the form of financial literacy and business skills training (accounting, business planning, etc.) would be necessary to provide new entrepreneurs with a solid foundation for accessing financing.

Address the agriculture gap by increasing the availability of funding, risk mitigation mechanisms, and technical assistance.

• On the funding side, portfolio guarantees would be attractive to lenders to reduce what they perceive to be the high risk of agricultural lending.
• Sector-specific credit lines are also needed
• Technical assistance is especially important and should focus more on helping financial institutions reduce the cost of serving agricultural enterprises.

Contribute to mitigating the loan gap by increasing the availability of portfolio guarantee products and lending to second-tier banks.