Central Bank publishes research on understanding SMEs in the Covid-19 pandemic

• SMEs account for over 1 million employees, or 68.4% of total employment in the Irish business economy.
• As the extent of the economic shock becomes apparent in Ireland, it is more likely that firms will need some form of external liquidity if they are to re-open after the shock.
• A loss of liquidity would amplify the economic downturn domestically due to close linkages in domestic supply chains.

The Central Bank of Ireland has today published two new Financial Stability Notes (FSNs). The first FSN, written by Niall McGeever, John McQuinn and Samantha Myers, is entitled ‘SME liquidity needs during the COVID-19 shock'. The second FSN, written by Fergal McCann and Samantha Myers, is entitled ‘COVID-19 and the transmission of shocks through domestic supply chains'.

In ‘SME liquidity needs during the COVID-19 shock' the authors note that SMEs are particularly important for job creation in Ireland. They account for over 1 million employees, or 68.4% of total employment in the Irish business economy. Personnel costs make up a high proportion of total costs in many sectors, and the authors report that the significant supports announced by the Irish Government in March will have eased the wage burden of affected SMEs.

The authors use a combination of sector- and bank-level data to estimate Small and Medium Enterprises (SME) liquidity needs over a three month period, under a range of scenarios. A key factor that will determine the overall demand for liquidity is the ability of firms to reduce non-personnel expenses such as rent, rates, tax, insurance, trade credit, debt repayments and utilities. The authors note that as the extent of the economic shock becomes apparent in Ireland, it is more likely that firms will need some form of external liquidity (with estimates totaling €2.4 billion and more depending on the scenario) if they are to continue to operate.

Noting the domestic banking system is an important source of liquidity for Irish firms, the authors report that for the latest sectoral data in June 2019, Irish SMEs had €2.7bn in undrawn credit available from Irish retail banks. Access to this varies across sectors, and is however likely to prove challenging for SMEs without collateral or an existing relationship with a lender.

In the event that private sector liquidity is insufficient to meet demand, the authors outline three options available to policymakers. These include credit guarantee schemes, lending schemes, and direct fiscal supports. The paper discusses each type of intervention from a theoretical perspective, noting that each type of intervention incorporates very complex and delicate trade-offs in its optimal design and execution. In Ireland, such supports include the pre-existing Irish Credit Guarantee Scheme, and the SBCI, Enterprise Ireland and MicroFinance Ireland schemes are involved in direct lending to firms.

In ‘COVID-19 and the transmission of shocks through domestic supply chains' the authors find that linkages through the supply chain represent an important potential transmission mechanism for the COVID-19 shock in Ireland due to the substantial economic activity that occurs between businesses across sectors in Ireland.

The research finds up to €40bn of annual sales of suppliers are to companies that are either highly or moderately affected by the restrictions placed on the economy as part of the public health response to COVID-19.

Given that trade credit is used heavily in Ireland relative to other European countries, a lack of liquidity among firms directly affected by current restrictions risks cascading through the supply chain, in the form of missed payments for goods and services already provided. This could lead to knock-on effects on firms further up the chain, as if the liquidity dry-up continues, it could amplify the economic downturn domestically beyond those firms currently unable to meet customer demand.