Corporate Finance: Interest rate hikes hit companies hard

Interest rates in the euro area are currently at a low. If the European Central Bank (ECB) abandons its expansive monetary policy, many companies could face financial difficulties, according to a study by the Cologne Institute for Economic Research (IW).

The ECB wants to boost the economy in the euro area with its expansive monetary policy. Businesses are profiting from the low interest rates: They can borrow money cheaply to invest or repay old loans. Unlike in the USA, where businesses mainly finance themselves on the capital market, companies in Europe are mainly dependent on bank loans for investments.

However, should interest rates rise, companies would no longer be able to get money so affordably. According to IW-calculations, almost 800,000 businesses, which account for 5.1 per cent of companies in the 11 countries surveyed in the euro area, would face financial difficulties due to increased debt, higher interest costs and a lack of revenue growth. Companies in Greece (9.4 percent), Italy (8.5 percent) and France (5.7 percent) would be particularly affected. Germany, however, would be better off: Only 0.7 percent of businesses would face problems. For this study, IW researchers have evaluated the ECB’s biannual survey on the access to finance of enterprises (SAFE) since 2009.

"Smaller companies are more vulnerable than big companies," says Markus Demary, IW financial expert. "The larger companies are also more often financed by shares and bonds. In addition, they often have a longer credit history. "Micro firms with up to nine employees and small companies with 10 to 49 employees are especially affected by funding shortfalls. But there are exceptions: In Greece, 10% of large companies with at least 250 employees would also experience financial problems in the case of increased interest rates; in Portugal and Spain, the percentage would likewise be above the euro average, which is 0.9% in this size category. A tightening of the European monetary policy should therefore be carried out with caution. "The ECB must take into account the impact on the economy in the event of a possible change in interest rates," Demary stresses.