Credit Quality and Substitution in SME Finance

Abstract

We investigate whether and how credit quality influences SMEs’ substitution of bank credit for trade credit. Using data from the five largest European countries, we find that substitution of bank credit for trade credit decreases during the financial crisis, but it decreases significantly less for ex ante low credit quality firms. We control for pre-crisis or lagged firm characteristics including size and external finance dependence, industry effects, sample selection effects and cross-country heterogeneity. We also find that low credit quality firms increase their absolute and relative trade credit usage significantly more than high credit quality firms during the financial crisis. The effects are consistent across countries and stronger for net trade credit borrowers and financially constrained firms. The evidence highlights how credit quality influences demand-side driven substitution in SME finance.

Keywords: Trade credit, bank credit, credit risk, substitution, financial crisis

JEL Classification: G20, G30, G32