The effects of recessionary stimulus programmes: New evidence from the UK’s Enterprise Finance Guarantee scheme
Loan guarantees to small businesses are emerging as a main policy response during the COVID-19 crisis. Using evidence from the UK’s Enterprise Finance Guarantee scheme from 2009, this column argues that such policies enable some financially constrained firms to retain workers that otherwise would have been laid off, and whose retention was fundamental in rebuilding the businesses post-crisis. However, less-educated workers in jobs with low training costs are more likely to be laid off, implying that the guarantee policy is regressive.
Governments around the world have enacted stimulus measures to minimise the economic fallout of the COVID-19 crisis. A popular policy is loan guarantees that increase firms’ access to credit. For example, in March 2020 the UK government unveiled a scheme for £330 billion in loan guarantees – equivalent to 15% of GDP – to provide businesses with cash to pay wages and other expenses.
Despite the large and increasing prevalence of loan guarantees, the evidence for the success of such schemes remains sparse. This is due, in a large part, to difficulties in accessing detailed data for small firms. It is also because constructing meaningful counterfactual scenarios is challenging. It is not straightforward to claim what the performance of firms would have been without such guarantees in place.
A recent paper provides novel insights into the effects of loan guarantee programmes that can help inform policymakers.1 In this column, we summarise the findings in Gonzalez-Uribe and Wang (2020). The research is focused on the Enterprise Finance Guarantee (EFG), the small-firm loan guarantees implemented starting in 2009 as part of the UK’s business policy response to the Global Crisis.
Policy design of loan guarantees
Loan guarantees were the main small business policy response to the Global Crisis. However, their effect is contentious. Supporters claim that these programmes alleviate financial constraints which can be especially costly for small firms during recessions. By contrast, critics argue that by allowing firms to borrow without pledging collateral, and by providing a guarantee, these programmes lower the lenders’ incentives to screen and discipline borrowers.
In responding to critics, the UK loan guarantees programme has several design features to curtail lenders’ and borrowers’ risk-taking incentives. Lenders are incentivised by the partial guarantees on individual loans (75% of outstanding balance) and the caps on the overall volume of guarantees sought by each bank (9.75% of the scheme’s size). Borrowers remain fully liable, and banks can request additional personal guarantees, thus incentivising banks to monitor.
Other features of the scheme also impact incentives. For example, the scheme is funded by charging a 2% premium to the borrowers in addition to the chargers by lenders (on average, 5.8%). The aim of the premium is to share the costs of the scheme between beneficiaries and taxpayers. However, an unintended consequence may be adverse selection. Perhaps as a result of this rationing, take-up was low relative to the target population. Less than 7,000 UK companies issued loans through the scheme in 2009, which corresponds to fewer than 5% of eligible firms.
The effects of the Enterprise Finance Guarantee
Our evidence in Gonzalez-Uribe and Wang (2020) is consistent with the guarantees enabling some financially constrained firms to retain workers that otherwise would have been laid off, and whose retention was fundamental in rebuilding the businesses post-crisis.
The estimation uses variation in participation from the programme’s firm-size unexpected eligibility threshold. For eligible firms near the threshold (and relative to non-eligible firms), the guarantees increased average four-year profits, productivity, survival, and employment growth, but not investment. The relative increases in performance and employment occurred in lockstep with debt issuances and were absent prior to 2009. They did not revert during 2010-2013, and mask large heterogeneity. This suggests that the results are entirely driven by industries with high costs to train employees.
Additional evidence suggests that these results are mainly driven by effects on the minority of eligible firms that take up the scheme. Under this assumption, annual returns to guaranteed debt range between 16% and 20%, which comfortably exceeds the above-market scheme rates, and is consistently below the cost of outside-funding options.
Why did more eligible firms not take up the loans? First, allowing banks to request personal guarantees pushed back the demand of firms that had none. Second, considerations other than economic benefit kept firms at bay. For example, firms may be averse to government scrutiny in a wider level.
Are guarantees a good policy during the COVID-19 crisis?
The main criticism towards loan guarantees is that they increase risk-shifting by banks and borrowers. The impacts on profitability and survival alleviate this criticism for the EFG. Another potential criticism is that guarantees negatively affect productivity by keeping workers in unproductive firms, preventing the efficient reallocation of labour. However, the positive productivity estimates allay this concern.
However, the question remains as to whether the EFG was good value for money. To answer this question we perform a back-of-the-envelope calculation. Under plausible assumptions, results show that for the sub-sample of eligible firms close the eligibility threshold, the EFG economic benefits were 1.5 times their costs.
An important policy answer in the debate as to whether governments should target firms or individuals (Baldwin and Weder di Mauro 2020) is that firm policies like loan guarantees can serve as partial social insurance. Eligible firms have incentives to retain workers, but only those workers that are hard to train and hire. This finding means that policies that only target firms are regressive, because poorer workers are the more likely to have jobs with low training costs.
Bachas, N, O Kim and C Yannelis (Forthcoming), “Loan Guarantees and Credit Supply”, Journal of Financial Economics.
Baldwin, R, and B Weder di Mauro (2020), Economics in the Time of COVID-19, VoxEU.org eBook, CEPR Press.
Barrot, J, T Martin, J Sauvagnat and B Vallee (2019), “Employment Effects of Alleviating Financing Frictions: Worker-Level Evidence from a Loan Guarantee Program”, Proceedings of Paris December 2019 Finance Meeting EUROFIDAI – ESSEC.
Bonfim, D, C Custodio and C Raposo (2019), “Information Frictions, Financing, and Growth: The impact of a Firm Credit Certification Program for Private Firms”, Working paper.
Brown, J D and J S Earle (2017), “Finance and growth at the firm level: Evidence from SBA loans”, The Journal of Finance 72(3): 1039-1080.
De Blasio, G, S De Mitri, A D’Ignazio, P Finaldi Russo and L Stoppani (2017), “Public guarantees on loans to SMEs: an RDD evaluation”, Bank of Italy Temi di Discussione (Working Paper) No, 1111.
Gonzalez-Uribe, J and S Wang (2020), “The Effects of Small-Firm Loan Guarantees in the UK: Insights for the COVID-19 Pandemic Crisis”, Discussion paper 795, Financial Markets Group, London School of Economics.
Lelarge, C, D Sraer and D Thesmar (2010), “Entrepreneurship and credit constraints: Evidence from a French loan guarantee program”, in Lerner, J. and A Schoar (eds) International Differences in Entrepreneurship, Chicago, IL: University of Chicago Press. 243-273.
1 Other relevant recent papers include Lelarge et al. (2010), Brown and Earle (2017), de Blasio et al. (2017), Bachas et al. (2019), Barrot et al. (2019), Bonfim et al. (2019).