Understanding SME interest rate variation across Europe

The cost of credit for small and medium enterprises (SMEs) differs considerably across the EU. This research begins by exploiting firm-level survey data to test whether differences in the characteristics of borrowing SMEs can explain cross-country variation in the cost of credit on new lending in 2014 and 2015. We find that new overdraft interest rates across the EU are lower for larger and older firms, and for those experiencing recent improvements in trading performance. However, controlling for such characteristics does not, in general, explain much of the overall difference in interest rates across countries. We extend the analysis by examining whether cross-country interest rate variation is associated with differences in the following key factors: banking sector cost efficiency; institutional factors relating to recoverability of collateral; existing and predicted default rates on SME lending; competition in the banking sector; banking sector risk and cost of funds; general macroeconomic performance. Using simple univariate correlations, we observe a significant positive relationship between interest rates and past/predicted SME loan defaults, and a negative relationship with the level of bank competition. Interest rates are also higher where banking stress is high and where unemployment is above historical levels. We find no correlation with banking sector profit/cost ratios, the cost of funds, or the efficiency of the insolvency system.