Financial Crisis And Capital Availability Of SMEs

Financial Crisis And Capital Availability Of SmesAbstract

SMEs is small and medium sized businesses. Their definition is not clear, but their contribution to the economy of the United States is undeniable. According to the United States, SMEs are businesses that employ less than 500 employees while the rest are large corporations. They are a source of employment to a number of citizens and create jobs for others. It is a source of income for both employers and employees. In addition, SMEs are a source of cost effective innovations that are essential for the development of the economy. In accordance, despite the fact that large corporations are the principal players in the manufacturing industries, SMEs are also pertinent to the service sector.

The financial, global crisis emanated from the housing industry. However, the consequences of the fall of the housing sector would eventually trickle down into other sectors. Large mortgage based companies were the first to indicate the possibility of having a crisis. Thereafter, the banking sector followed suit, and the motor industries suffered during the period. The failure of some the giant corporations was the indicator that the crisis would affect the entire economy. When the Lehman Brothers filed for bankruptcy, all the other financial institutions realized they needed to guard their finances. The effect of this was that businesses regardless of their size would not access funding from the banks. SMEs suffered immensely because of this turn of events. Banks were not sure about the companies to lend their money because of the instability that was going on during that period. In accordance, banks avoided engaging in any business that would risk their chances of survival during that period.

The tightening of monetary policies by banks was affecting SMEs. Capital availability was the chief sufferer of the financial crisis. SMEs, in most cases, operate by borrowing money from the banks and thereafter repaying the same amount. However, with a financial crisis that had some of the largest organizations collapsing, the banks would have to increase their care while lending money. Banks lacked a method that they could use to identify favorable customers for lending. This is because institutions that were financially stable yesterday would file for bankruptcy today. In accordance, many SMEs were not accessing funding, and this was severely affecting their operations. Many SMEs collapse and other operated facing constraints to survive through the period. This affected the entire economy because of the discussed relevance of SMEs.

The government of the United States through the Federal Reserve Bank intervened by cutting interest rates. Cutting of rates did not have the desired effect, and as such, the government opted to use quantitative easing. There were no accurate methods of determining the actual effects that the program had, but it was clear that, without its existence, SMEs would close. The United Kingdom also used the method and research indicates that there was some of level of benefits from quantitative easing. In the United States, FRB bought mortgage backed securities and other bonds to increase the amount of money in circulation.

Introduction

In 2008, the United States faced one of the worst financial crises of the modern history. The financial crisis emanates from the United States itself because of risky behaviors in the housing segment of the economy. Banks and mortgage lending companies filed for bankruptcy while others collapsed entirely. The entire world was now facing a substantial financial and economic crisis. SMEs is small and medium sized companies, and their definition varies from one country to the other. Despite the difficulty of defining SMEs, there is significant evidence that they are indispensable in the economy. They contribute immensely to the growth of the economy through a number of ways. In the United States, SMEs contribute in the creation of jobs, innovations, and in the gross output from the economy (United States Congress, 2011). This is a clear indication that SMEs are essential for the growth of an economy.

During the 2008 financial crisis that occurred throughout the world, businesses suffered because of their inability to access funding. Governments were working out policies that would assist their economy to recover from the financial crisis. Among them was quantitative easing whose mandate was ensuring that there was sufficient money on circulation to ease on the interest rates (United States Congress, 2010). This method did assist many businesses to avoid collapsing. However, the impact of the program was not easy to assess. There is, however, sufficient evidence to conclude that the financial and economic crisis of 2008 did affect the capital availability for many in the United States. Many Banks were not willing to lend money because of the obvious uncertainty present during that time.

The Financial Crisis

The United States experienced the worst financial turmoil since the great depression in the period between 2007 and 2009. Lending markets were the source of the turmoil (Aaron, 2009). Initial indications were that there would be a problem emerging. This occurred when the Federal Home Loan Mortgage Corporation did announce it would no longer purchase the mortgages of high risk. In addition, much later in the period New Century corporation did announce that they would file for bankruptcy. This sent a message to the housing sector that a crisis was looming and that it would happen soon. The anxiety led to a decrease in the price of houses and an increase in the number of foreclosures. The consequence of this is that credit rating agencies in the United States reduced their assessments of risks in financial instruments that used asset for backing.

Federal Reserve sought to extend its support to firms that were dealing with a mortgage or finance in the period of tight credit (Angelides, 2011). They used auctions and short term lending to conduct the sale of financial products related to the mortgage sector. Unfortunately, such measures did not prevent the crisis that was already having shape. The price of assets continued to decrease and institutions were seeking to reduce risky burdens by relieving themselves of the risky capital ratios. Another indication that the crisis was in an advanced level was the sale of Mortgage dealer Country Financial to the Bank of America for a tune of $4 billion in January 2008. In addition, other numerous firms had their credit ratings decreased because of the looming crisis. After the severe damage of Bear Stearns, that had made heavy investments in the securities having the backing of mortgage, United States was officially in a financial crisis.

There was an increase in delinquency and default rates. On the other hand, mortgage players were facing the problem of falling value of collateral (Aaron, 2009). IndyMac that according to studies was the largest mortgage lender in the entire of the United States fell on July of 2008. All the assets of the company became the property of the federal government. For dealing with the problem that was now threatening to tear up housing sector and the banking sector, the government started sponsoring mortgage firms. However, the consequence of this is that the problems that were facing the housing industry became apparent with the rising capital. That is the move did not help in easing the problem at all.

It was not until in September and October of 2008 that the crisis entered the banking sector. Lehman Brothers was the first bank to file for bankruptcy under chapter 11 (Krugman, 2009). This was because the bank did not have the required capital for the purposes of underwriting the securities. Lehman failure was a clear indicator that the government was either not in a position or was not willing to bail out all banks (Halm-Addo, 2010). This led to a spike in the inter-financial institutions lending. A day after the failure of Lehman Brothers, AIG (American International Group) borrowed $85 billion from the Federal Reserve Bank of New York. Thereafter the same month the other investment banks in the country, namely Morgan Stanley and Goldman Sachs, became holding companies for the banks (Aaron, 2009). This was for having an increased access to capital.

This news became viral and was all over the media and internet. Financial markets responded to the news negatively. In accordance, the financial markets both in the United States and abroad increased their volatility. Dow Jones Industrial Average was a clear indicator of the degree of volatility. An index comprises of the largest companies publicly listed. There were tumultuous changes on a daily basis and September it did register the largest single day drop. Investor confidence in many of the world economies decreased significantly. In accordance, investors were seeking to invest in nonfinancial assets. Many investors opted for safer assets such as the US dollar, oil, and gold. This was the reason that treasury bonds became high such that their returns were almost zero. They were attractive in comparison to the financial markets. Decreasing confidence in the money markets and sectors was negatively affecting the economy of the country.

There was an increase in the tightening of credit channels in New York and London. London had an interbank offer rate that was more than the interest generated from treasury bills for a period of three months. London interbank offer rate (LIBOR) was also more than the three-month Federal Reserve funds rate. Experts indicated that this was a clear indication that counterparty risk was increasing significantly. However, the most pertinent issue is that fact that there was a freeze on the paper market (Nanto, 2010). This prevented firms from giving out debt on the short-term basis that was necessary for their survival. The implications of the move were that there would be an extension of the problems to industries and other businesses.

Professionals warned that restrictions on credit would have a negative effect on the economy, and this would later happen. The United States automobile industry was the first recipient of the repercussions that the move would have. In 2009, there was an overall 31.9 decrease in the sales of cars. Next on the list was the retail sector. Their sales dropped by a margin of 2.8%. In the retail sector, companies such as MacDonald and Wal-Mart would escape the severe damage that was wiping the entire sector. Many industries and retail organizations started to lay off staff to cut on spending so that they can survive the period. This trend led to the loss of employment by millions to Americans (Nanto, 2010). In accordance to this, unemployment in the country did increase to 7.2%, which was an abnormal figure in a developed country such as the United States.

Research (Nanto, 2010) indicates that, after a financial crisis, the profits in an economy will obviously decrease. In accordance, during the recovery period organizations and other sectors are keen on trying to restore the profit margins. There are many ways that capitalists restore profit. This was the scenario in the United States after the global financial crisis. United States was not the only country suffering from the decreasing profits (Peters, 2010). All capitalist nations of the world suffered the same fate. Marxists theory indicates that the cause of such a trend is the twin evils. The first one is higher rates of unemployment and inflation (Muller, 2011). Reduced profits had the meaning that businesses were operating under reduced profits or losses (Michael, 2010). In accordance, investments towards businesses decreased significantly. The consequence of this was an increase in inflation, and unemployment. Obtaining capital to start a business become difficult because of lower profits.

One of the strategy that capitalist countries have been using since the financial crisis is that of inflation. Increasing prices of commodities at an accelerated rate has the meaning that wages will reduce. A decrease in wages or avoiding an increase in wages has the meaning that benefits of increasing productivity go to the generation of higher profits. Many employees of the large corporations face the challenge of either losing their jobs or accepting to receive lower wages (Muller, 2011). Cutting on health insurance is another strategy that capitalist countries are fond of using during the financial crisis. In accordance, workers have to pay higher premiums to get the economy back on track.

The changing fortunes in the money market were affecting small and medium sized companies. For the purpose of surviving and recovering from the financial and economic scare, they had to overwork their employees and seek increased working speeds. This was the known method of ensuring that there was an increase in the profits of the company. In this strategy, businesses would lay off a portion of their workers, and the remaining workers would do that work. This had an effect of increasing labor before the lay off because workers worked hard to ensure that they were not among the workers that the business would lay off (Muller, 2011). Decreasing the number of employees with constant workload increased the profits. However, the gains made were not sustainable because employee turnover would decrease eventually. In addition, despite initial increased labor efficiency, with time employees become fatigued and stressed. This will reduce their efficiency and reverse profits to the initial margins.

Many factors emerged during and after the financial crisis. However, lending came under scrutiny. There was a decrease in the value of collateral, which had the meaning that lending agencies were overly cautious. Business ventures had dwindled profits, and, despite having various strategies, the profits were below expectations. In accordance, banks and other lending institutions were not willing to lend their money to businesses unless there was a clear indication that such businesses would make profits (Muller, 2011). It was, therefore, difficult for businesses to acquire necessary capital to assist them start their projects. In addition, an increase in layoffs and pay cuts reduce the amount of money in circulation that would be critical to kick start small businesses. In accordance, the trend in the financial and the economy was not lonely affecting the large corporations but also smaller businesses.

Small and Medium Sized Companies

Many organizations and governments use the term SME, but there is a lack of universal definition of the term. In Chile, classification of companies depends on the annual turnover of those companies (Deese, 2009). On the other hand, South Africa uses the number of employees, gross asset turnover, and the gross turnover to classify companies. Indian companies that have less than million rupees in assets are small enterprises. In the US, companies that have lesser than 500 employees what professionals refer to as SMEs. Small and medium sized vary in type and industries. Activities across the SMEs cut across all sectors of an economy. In most cases, these companies are the largest contributors to the economy of any nation regardless of whether it is developed or developing.

Despite the fact that it is not possible to define SMEs, there is an agreement that it is a crucial sector of any country. In an example, in Chile SMEs account for the 100,000 production units with the Chilean market. On the other hand, in the United States 99.9 percentage US nonfarm businesses that are private are SMEs (Deese, 2009). SMEs in America vary in various ways from their size and the sectors that they represent. They represent farming, industrial, manufacturing, and other sectors within the economy. The contributions that SMEs make to the economy of the country are many (Council of Europe, 2009). They provide employment to millions of citizens and are a source of revenue for the government (Deese, 2009). Studies indicate that of the 6 million businesses that were nonfarm and had employers only 0.3% had more than 500 employees. This has the meaning that most of the businesses in the United States ate either micro, small, or medium sized companies.

In the United States, SMEs are significant contributors to the economy of the country. That is in terms of providing employment, entrepreneurship, creation of jobs, and the economic activities of the country according to the measurements of the Gross Domestic Product (GDP). Statistics indicate that SMEs contribute to more than half of the nonagricultural GDP of United States. Service sectors are the largest contributors to the economy through the SMEs followed by manufacturing while mining and construction also contributes significantly to the economy. In addition, creation of Jobs by the SMEs accounted for an overall 64.1 % of the total number of jobs created in the United States between the periods of 1992 to the end of 2009 (Bhaird, 2010). Evidently, SMEs are indispensable to the economy of the United States.

In 2004, SME exports amount to 3.8% of the GDP generated from SMEs. This is relatively low given that large enterprises had 11.5% of their GDP generated from exports. Such figures indicate that there large enterprises are industries that produce goods (Bhaird, 2010). In addition, larger firms export more products in comparison to their SME counterparts given that they have lesser constraints in terms of resources than SMEs. However, there is large informational gap on issues concerning SMEs. This is because there are many small and medium sized companies that export their products indirectly (Bhaird, 2010). This has the meaning that it is difficult to conclude that SMEs export lesser goods than large corporations. This is because a large number of them export through intermediaries such as wholesalers.

Statistical data indicate the importance of SMEs in the creation of jobs. According to reports, of all the jobs created SMEs accounted for more than 64%. There was an even distribution of job creation among the SMEs in the periods between 1992 and 2009. That is all SMEs uniformly contributed to the growth of job creation regardless of the size of even sector. Dissecting the data further indicates that SMEs with fewer than 20 employees accounted for 38.4 growths in the job creation. On the other hand, 22.7 came from firms having more than 500 employees. However, there are also indications that the small firms are relatively unstable in comparison to the larger firms (Bhaird, 2010). Data indicates that, despite the contribution in the growth of jobs, small firms alto contribute to an overall 39.1% loss in jobs. This has the meaning that large companies are more stable that their SME counterparts reflected in their low job loss incidences.

It is relevant to understand the actual contribution of SMEs to the United States economy. Studies indicate that SMEs contributed to approximately $5 trillion to the economy of the country in 2004. The service sector was the most prominent sector and contributor to SMEs contribution to the economy (Antony, 2011). 79.1% of the total contribution to the GDP by the SMEs came from the service sector. Combining the wholesale and retail sectors of the economy provides that largest share of the SME GDP. That is both have an overall share of about 15.3%. Professional, technical, and scientific enterprises contribute to 11.1% while manufacturing and accounting accounted for 11.0%. Last on the list was the construction sector with a total contribution of 10%.

Comparing the data for SMEs with that of large corporations indicates a contrast between the two. Unlike in the small and medium sized category of enterprises where service sectors are the largest contributors, manufacturing and mining companies are the giant contributors in this category (US international Trade Commission, 2009). Studies indicate that mining and manufacturing companies contributed 23.3% to the GDP of large corporations. These are statistics for the end of 2004. After the mining and manufacturing industry, the second largest contributor to the economy of the large corporations is the retail and wholesale sector. In addition to these differences are the roles of various sectors of the economies to the two categories of enterprises. Financial and insurance companies play a large role in large companies while, on the other hand, technical, scientific, and professional companies have the largest role in SMEs.

From previous discussions, there is sufficient evidence that SMEs are a significant contributor to employment growth in the United States (Liario, 2011). However, this is not the only sector that SMEs contribute. SMEs are relevant source for innovation in the economy and promote ideas of scientists and other professionals. In addition, SMEs also provide opportunities to all citizens of the United States regardless of their gender or color. That is through SMEs citizens from across all corners of the country grow their entrepreneurial skills. In addition, it is a magnificent avenue for individuals with the society to learn various ways of managing a successful business (Liario, 2011). This does not only contribute to the harmony of the country, but is also a channel of indirectly creating employment opportunities, as well as entrepreneurial skills.

Professionals indicate that to measure the worth of business venture patent fillings provide a remarkable method of approaching the issue. SMEs provide an adequate avenue for products, services, and processes. Recent studies indicate that small and medium sized enterprises have higher patents per employee than their counterparts do in the large corporations. This is a clear indicator that SMEs provide adequate and appropriate environment for innovators relative to large enterprises. In addition, the innovations from SMEs are technologically distinguished according to the metrics. This has been because of the cost effectiveness of their research. Given the number of scientific innovations that emanate from SMEs and their expenditure, there is evidence that SMEs maximize on profits while ensuring low production costs. While both large firms and SMEs are active in the field of innovation, research indicates that SMEs are more efficient that their counterparts in the large corporations.

In addition to being an avenue for innovations, SMEs also provide opportunities to minority communities in the United States. This is essential because it does not only provide harmony in society, but also a source of equality within the society. When the economy provides equal opportunities to people, regardless of their race or gender that the economy will grow substantially. SMEs seem to upholding this ethical virtue more than the large corporations uphold. Studies indicate that in 2002 minorities owned approximately 18% of the businesses in the country. A large portion of this business falls under the category of small or medium sized enterprises. This is contrary to large corporations that tend to have a large proportion of majorities owning the companies (Liario, 2011). In accordance, SMEs provide opportunities to all citizens in the country.

27% of the labor force in 2002 came from the minority community according to statistics from 2002. Companies that had fewer than 500 employees recorded a minority ownership of approximately 11.6 %. This is against statistics taken two years later in 2002 that indicate that minorities only owned 2.5 % of the large corporations. 85% of corporations owned by the minorities employed lesser than ten workers in comparison to 80% for the white owned organizations. In addition, SMEs are essential to minorities and immigrants given that they are their source of employment that allows them to send remittances back to their home countries. Recent studies also indicate that among individuals that form high-tech companies at least one of them is either an immigrant or a minority. This is an indication of the importance of minorities in the United States economy. SMEs is performing remarkably well in ensuring that they nature such individuals.

Capital Availability

Capital availability is the ability of companies such as SMEs to turn their assets into funds. Availability of capital is a large player in the process of mandating transaction because they make funds available for the purposes of such transactions. Companies and in this case, SMEs have to ensure that they evaluate the effects that the transaction will have on the future of their business. This will require an assessment on liquid assets need and a consideration of current market issues and trends. In addition, to have right understanding international transactions, assessing transaction management is essential. Such issues include taxes and the compliance of a corporation to financial requirements (Martin, 2009). In accordance, the availability of capital becomes a critical aspect for the growth of any organization. SMEs require capital to finance their daily operations. That is research, investments and innovations.

Availability of capital is one of the factors that severely damaged SMEs during the financial crisis in the United States. Access to finance is one of the issues that affected the growth of SMEs during the financial crisis period. The government responded by loosening policies governing monetary principles, and also encouraging lending and the rolling out of stimulus by implementing fiscal policies (Chauffour, 2011). Policymakers tried coming up with strategies that would ensure that the problems that large corporations were facing did not trickle down to SMEs. However, financial constraints that large corporations were facing would eventually become part of the problem for the small and medium sized companies. Capital availability issues did not only affect SMEs in the developed world, but also those in the developing countries.

Many countries have been experiencing a credit tightening because of the problems that the banking sector was experiencing (Paci, 2008). Various countries both developing and the developed were suffering from the credit tightening, which was adversely affecting the SME businesses. According to a survey conducted in America and the Caribbean, 58% of governments within the region indicated that there was an overall decline in the credit available to SMEs. The United States specifically was expecting that there would be a slowdown in the rates of lending among the lending corporations. This is because financial institutions in the country were trying to consolidate their financial positions. Banks and other financial institutions were undertaking precautionary measures for the purposes of guarding themselves against default and delinquency.

The measures that financial institutions, in both the United States and elsewhere, were undertaking decreased the chances of enterprises accessing credit. Such measures had the meaning that there was a reduction in the new lending flow and the extension of existing credits (Meier, 2010). Lenders could not find an appropriate method to use in accessing the credit worthiness of a company. During the crisis, a company would be stable in a given day and its crumble the next day. In accordance, even the SMEs that had significant financial records were experiencing difficulty in accessing credit (Paci, 2008). This meant that many in the United States were facing considerable challenges on issues concerning capital availability. Without sufficient capital availability, SMEs had a challenge of sustaining their operations in some instances leading to the closure of some of SMEs.

In the United Kingdom, the number of small and micro businesses that closed rose dramatically to 85% in the year 2009 (Heine, 2009). According to the Small Businesses Federation, orders were decreasing with the increasing cost and the banks were not willing to help ease the situation. Micro, small, and medium sized enterprises that were initially accessing capital in real time could be no longer access credit according to reports (Spence, 2012). In accordance, most of the small enterprises had no other option but to close their businesses. The consequence of this was that fewer corporations were engaging in investment especially in countries such as the US where the crisis was strongest. In addition, banks and other lending institutions were monitoring all the proposals of investment closely (Heine, 2009). This was for understanding the worth of crediting such projects.

Despite the fact that there were worries of the lack of capital by SME policymakers, working capital was the largest source of worry (Horowitz, 2008). Enterprises had to ensure that they had working capital that was sufficient to avoid downfall. Such capital was necessary for settling for the services and goods delivered in the premises of such an organization. To ensure that there was sufficient working capital decision maker had the mandate of ensuring that the company adheres to a number if restrictions (OECD, 2012). They involve ensuring that there is astute flow of cash through management, tracking of receivables in accounts, ensuring maximum use supplier credit, and finally management of overdraft. Fortunately, for SMEs, most of the countries were trying to implement policies that would ensure that there was an increase in the availability of capital.

Credit squeeze will affect inter-firm trade because of the lack of finances. SMEs in most cases operate through larger firms (Masci, 2009). That is they sell their products to larger firms and at times use the large corporations for the purposes of exporting. In addition, small companies either sell or seek finances from the larger corporations when the latter uses the former’s patents. In accordance, there much of the working capital for the small organizations comes from the larger firms. However, during the financial crisis SMEs were facing challenges accessing such finances. Larger firms, in most cases, during the crisis do not send payments in a timely manner to smaller firms because of power imbalances evident between the two trading partners (Masci, 2009). This further squeezes the credit availability for SMEs by reducing their working capital further.

Small firms in most cases depend on the on credit that comes from suppliers so that they can meet their operating capital. It is unfortunate that, during the financial crisis it is not possible to acquire credit using this method. This is because it is either difficult for SMEs to acquire this capital or the terms of acquisition are tougher than previous periods. The meaning of this is that for survival small companies have to come up with other methods of obtaining credit to service their working capital during financial turmoil (Masci, 2009). One of the ways that SMEs applied was acquiring capital though overdraft if such corporations have excesses. However, during the financial crisis instances that a company might have an overdraft are relatively lower than during other periods. Therefore, the other mode of acquiring capital is through the usage of the new government lending in countries that had such an arrangement.

Some SMEs and household based micro enterprises depend on microfinance. These organizations rely on microfinance for their working capital, and for the necessary investment in innovations and infrastructure (Dan, 2011). Despite its dependence on the business, financial crisis increase pressure on this source of capital to the disadvantage of such organizations. However, SMEs that is deposit-based fared better than their non-deposit counterparts did. This is because the latter depend on finances that are outside the company and are volatile. Financing of small business in the US is becoming scarce. During the financial crisis and thereafter, foreign investments became lesser because of the risks involved in the fluctuating exchange rates (Springbelt, 2012). This has the meaning that SMEs that were depending on exte