Substitution effects in private debt: evidence from SMEs

Abstract

The external finance of small- and medium-sized enterprises (SMEs) is limited to private debt such as bank credit and trade credit. SMEs generally prefer bank credit over trade credit because the former tends to be less expensive and more flexible than the latter. We investigate whether SMEs with positive demand for debt finance increase trade credit when they experience a negative shock to bank credit. We base our analysis on a large sample of SMEs from France, Germany, Italy, Spain and the United Kingdom. First, SMEs’ ability to substitute largely depends on their credit quality. Second, substitution was less likely during the financial crisis of 2007-09 and declined as the crisis deepened. Third, high credit quality firms with intermediate financial constraints are the most likely to substitute. We confirm these results on a rich subsample with matched bank-firm data. The evidence suggests that policymakers should stabilize bank credit supply to mitigate adverse economic effects rather than promote trade credit as an alternative.