The Role of Banks versus Venture Capital in Financing Small Enterprises in Successful European Regions (CBR project)

Overview

Aims and objectives

This project focused on the funding of SMEs in different regions in Europe against the background of increasing integration of Europe’s financial space, and the specific context of dramatic transformation of regional and local banking systems and the emergence of a venture capital market. The project sought to address 2 main questions:

1. What are the implications of the restructuring, reorganisation and transformation of local and regional banking systems across Europe for the role of such banks in funding and supporting the SME sector? Local and regional banks, many of which have traditionally had close relationships with their local economies, and with local businesses, are being rationalised part of a wave of merger and reorganisation activity that is sweeping through Europe’s financial system. Financial integration, deregulation and intensifying competition between banks are driving this process. The concern is that what appears to be increasing centralisation of banking will have detrimental effects on the links between local firms, especially small and medium sized enterprises, and local banks, and the access of such firms to loan capital. This part of the project seeks to determine whether this fear is justified.
2. To the extent that a bank funding gap is emerging amongst SMEs, other sources of finance are likely to be of growing importance. One of these is the emerging European venture capital market. The second strand of the research will examine the nature, extent and role of this new circuit of finance for the SME sector. At present the venture capital market is unevenly developed, being much more advanced in the UK than in other member states. The research will endeavour to identify the reasons for this uneven development, and to assess whether the emergence of, access to, and scope for venture capital funding of SMEs is likely to benefit some local economies more than others. Are we seeing – as the evidence for the UK seems to suggest – the development of a geographically biased system of finance provision for SMEs in which both bank finance and venture capital favour certain (typically successful) regions over other (typically less successful) regions?

Progress and findings

Detailed analysis of the geographies of venture capitalism in the UK, Germany, France, the Netherlands, and Italy reveals that in each case venture capital activity is markedly skewed towards certain regions (using location quotients to measure spatial concentration), specifically the more dynamic and successful regions, where small firm formation rates and high technology activity are also highest. This distribution in turn closely follows the location of major financial centres in the countries concerned. This raises some key issue for policy, in that the European Commission has argued that venture capitalism in the EU is too spatially dispersed, and needs to be even more spatially concentrated if Europe is to create the highly successful high technology locational clusters found in the US. The OECD, on the other hand has argued that there are venture capital shortages in less prosperous regions and that until venture capital is more evenly spread geographically, new and small firm activity in peripheral and less developed regions will continue to lag behind that found in the more dynamic and prosperous regions. This research suggests that the EU seems to suffer from the worst of both worlds.

Major postal surveys of over 800 high-tech SMEs and venture capital firms in 3 case study regions – Outer South East England, Bavaria in southern Germany, and Emilia-Romagna in Italy, have also been undertaken. This has been combined with an examination of the restructuring of banking systems across EU member states, and in particular the changes occurring to systems of local and regional banking. Extensive and detailed work has been undertaken on the merger movement in banks in southern Germany. The German data indicate that as concentration and consolidation has proceeded apace since 1990, spatially the process has been one of intra-lander bank consolidation, with cross-lander take-overs and mergers far less common. This has led to a reduction in the number of local banks and also in the number of branches, and in the creation of larger banks with a more extensive, geographical coverage within each region, but still confined largely to individual länder. Thus far, there appears to have been little evidence of the inter-regional centralisation postulated by some influential writers in this area, although there is some suggestion of centralisation in the larger towns and cities at within länder.

The changes to regional systems that have recently taken place in Italy and Germany have been particularly pronounced, involving in each case a substantial reduction in the numbers of banks and a major reorganisation and consolidation of local and regional banking systems. Across much of the EU, local banks have traditionally provided an important source of finance for local SMEs. Two rather different arguments have been advanced as to how the current restructuring of local and regional banking systems in the EU will change this traditional role: on the one hand that bank consolidation will lead to a reduction in the supply of local finance, and on the other that it will in fact increase the supply as larger regional and national banks tend to be less risk averse, more efficient and cheaper. While this research finds some support for the second argument in both Italy and Germany, the evidence for bank funding of SMEs in the UK regions suggest that regional financing gaps could open up in Italy and Germany as the latter move increasingly to the sort of banking system found in the UK.

Project leaders

Ron Martin
Peter Sunley (University of Southampton)

Junior research fellow

Dave Turner

Project status

Completed