Financing SMEs and Entrepreneurs 2020

27. Latvia

Key facts on SME financing

Growth of the Latvian economy was considerably faster in 2017 and 2018 than in the previous years. Export, investments, private and public consumption are growing steadily. Export volumes have reached their highest-ever level. An increase is observed in almost all sectors of the national economy. Overall, in the three first quarters of 2018, the gross domestic product (GDP) increased by 4.7% achieving a higher increase than in 2017, when GDP increased by 4.6%. Taking into account economic growth in countries of the European Union (EU), as well as investments available from EU funds, economic growth is expected to remain stable also in 2019, even though at a slower rate.

In Latvia, 99.8% of economically active merchants and commercial companies are SMEs, and 92.1% of these SMEs are micro-enterprises.

Loans to SMEs dominate in the banking sector’s lending to non-financial corporations (NFCs), as SMEs play an important role in the domestic economy of Latvia – loans to SMEs comprised 74% (at the end 2018) of total loans to domestic NFCs. The outstanding amount of banking sector loans to SMEs decreased in 2018 by 8.3%. However, to a large extent this is attributed to structural changes in the Latvian banking sector (for instance, the withdrawal of the credit institution's licence). Excluding one-off effects, the SMEs loan stock did not change significantly (-1.0% year-on-year). In 2018, the new lending (flow) to SMEs was slightly higher than in 2017 (by 3.9%). Overall, the economic environment remains favourable, driven by investment growth and domestic demand. The balanced economic growth is expected to continue (the Bank of Latvia forecasts 2.9% real GDP growth in 2019) and will support credit demand.

Venture and growth capital increased in 2017 from EUR 79.4 million to EUR 120 million. In 2018, 3 new acceleration funds in addition to several seed, start-up and growth capital funds were introduced to the market to facilitate the development of venture capital investments.

The state promotes access to funding (through its micro-lending, start-up, and loans programme) for firms lacking the financial credibility (collateral, net worth, cash flow and credit history) that is necessary to access funding from commercial banks or private investors.

Currently, state support programmes are introduced via the JSC Development Finance Institution Altum (ALTUM), a state-owned development finance institution offering aid and financial tools to various target groups. ALTUM develops and implements state aid programmes to compensate for market shortcomings that cannot be resolved by private financial institutions.

Table 27.1. Scoreboard for Latvia

Indicator	Unit	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018
Debt
Outstanding business loans, SMEs	EUR million	7 727	8 672	8 376	7 764	7 035	6 154	5 404	4 939	4 771	4 942	4 482	4 110
Outstanding business loans, total	EUR million	8 865	10 359	9 681	8 888	8 212	7 474	7 058	6 379	6 274	6 373	5 887	5 591
Share of SME outstanding loans	% of total outstanding business loans	87.16	83.71	86.52	87.34	85.67	82.34	76.57	77.43	76.05	77.55	76.1	73.52
New business lending, total	EUR million	..	..	..	..	1 708	1 914	1 965	1 268	1 346	1 795	1 347	1 312
New business lending, SMEs	EUR million	..	..	..	..	1 506	1 625	1 613	1 020	947	1 399	974	1 012
Share of new SME lending	% of total new lending	..	..	..	..	88.20	84.90	82.08	80.47	70.39	77.95	72.3	77.19
Outstanding short-term loans, SMEs	EUR million	2 653	3 203	3 262	3 009	2 682	2 349	1 852	1 570	1 672	1 371	1 287	1 229
Outstanding long-term loans, SMEs	EUR million	5 048	5 409	4 912	4 701	4 353	3 805	3 552	3 369	3 099	3 571	3 195	2 894
Share of short-term SME lending	% of total SME lending	34.4	37.2	39.9	39	38.1	38.2	34.3	31.8	35.1	27.7	28.7	29.8
Non-performing loans, total	% of all business loans	0.7	3.2	20.2	20.8	16.4	9.7	6.9	5.9	4.4	2.7	3.1	2.5
Non-performing loans, SMEs	% of all SME loans	0.8	3.7	22.4	23.4	18.8	11.7	8.4	7.2	5.7	3.3	3.8	3.3
Interest rate, SMEs	%	8.3	8.9	7.9	7.1	5.8	4.5	4.5	4.7	4.5	4.4	3.8	3.8
Interest rate, large firms	%	6.6	7.1	5.2	4.3	4	3.6	3.8	3.3	3.1	2.5	2.6	2.7
Interest rate spread	% points	1.7	1.8	2.7	2.8	1.8	0.9	0.7	1.4	1.4	1.9	1.2	1.1
Non-bank finance
Venture and growth capital	EUR million	..	..	..	..	..	..	..	37.95	51.98	79.37	101	118
Venture and growth capital (growth rate)	%, Year-on-year growth rate	..	..	..	..	..	..	..	..	36.97	52.69	27.76	16.45
Leasing and hire purchases	EUR million	1 576	1 594	1 145	841	810	867	875	864	932	939	1 034	..
Factoring and invoice discounting	EUR million	227.24	301.90	149.13	60.68	90.96	96.15	108.01	114.47	151.81	165.99	152.64	..
Other indicators
Bankruptcies, SMEs	Number	..	1 620	2 581	2 549	822	880	820	959	803	730	588	..
Bankruptcies, SMEs (growth rate)	%, Year-on-year growth rate	..	..	59.32	-1.24	-67.75	7.06	-6.82	16.95	-16.27	-9.09	-19.45	..

Source: See Table 27.3.

SMEs in the national economy

According to provisional data from the Central Statistical Bureau, there were 113 755 economically active individual merchants and commercial companies in Latvia in 2017. 99.8% of these firms were SMEs and 93.1% of SMEs were micro-sized. Only 0.2% of firms in Latvia in 2017 were large firms (see Table 27.2)

Table 27.2. Distribution of firms in Latvia, 2017

Class size	Latvia Number of enterprises			Number of persons employed			Value added
	Latvia		EU-28	Latvia		EU-28	Latvia		EU-28
	Number	% share	% share	Number	% share	% share	Billion €	% share	% share
Micro	104 795	92.1	93.1	208 970	33.5	29.4	2.5	20.9	20.7
Small	7 344	6.5	5.8	146 547	23.4	20.0	2.8	23.0	17.8
Medium	1 421	1.2	0.9	138 276	22.1	17.0	3.2	26.1	18.3
SMEs	113 560	99.8	99.8	493 793	79.0	66.4	8.5	70.0	56.8
Large	195	0.2	0.2	131 173	21.0	33.6	3.6	30.0	43.2
Total	113 755	100	100	624 966	100	100	12.1	100	100

Note: These are estimates for 2017 produced by DIW Econ, based on 2008-2015 figures from the Structural Business Statistics Database (Eurostat). The data cover the ‘non-financial business economy’, which includes industry, construction, trade, and services (NACE Rev. 2 sections B to J, L, M and N), but not enterprises in agriculture, forestry and fisheries and the largely non-market service sectors such as education and health. The following size-class definitions are applied: micro firms (0-9 persons employed), small firms (10-49 persons employed), medium-sized firms (50-249 persons employed), and large firms (250+ persons employed). The advantage of using Eurostat data is that the statistics are harmonised and comparable across countries. The disadvantage is that for some countries the data may be different from those published by national authorities.

In the Latvian ‘non-financial business economy’, SMEs account for 70.0% of value added and 79.0% of employment, significantly higher than the respective EU averages of 56.8% and 66.4%. The annual productivity of Latvian SMEs is slightly less than EUR 17 200 per person, less than half of the EU average of EUR 43 900. The majority of SMEs are represented in wholesale and retail trade and manufacturing, with a combined contribution of 44.9% to total SME value added and 43.4 % to SME employment.

In 2013-2017, the value added of Latvian SMEs rose by 25.6%, slightly less than the 27.5% growth of large businesses. SME value added growth accelerated in 2016-2017, with SMEs generating a two-digit increase of 11.5%, against the modest annual gains of 3.9% in 2014-2015 and 2.4% in 2015-2016. SME employment increased by 8.4 % in 2013-2017, largely thanks to micro firms, which created 24.8% more jobs, whereas small and medium firms reported a decrease of 1.2% in employment in the same period.

In total, 10 210 new companies were registered in 2017, the lowest number since 2009 and 8.9% lower than in 2016. The overall decrease in company registrations in 2016-2017 can be explained as a reaction to extensive tax reforms in recent years and uncertainty about impending regulations in 2017 and 2018. The number of liquidations (de-registrations) increased by 34.7% in 2016-2017, totalling 16 479 companies, a net loss of 6 269 firms. This increase in liquidations was partially due to the removal of inactive companies by the country’s Register of Enterprises in recent tax and law reforms.

In 2015, 1 051 firms in the ‘business economy’ with at least 10 employees could be classified as high-growth firms. This represented 12.2 % of all firms in Latvia, which is substantially higher than the EU average of 9.9 %. However, in contrast to the trend in the EU, this percentage has continued to fall for the third year in a row.

Growth in SME value added is predicted to slow down to one-digit rates of 7.4 % and 7.9 % annually between 2017 and 2019. However, it will still exceed the annual growth rates of large firms. SME employment is likely to rise by around 2 % annually in 2017-2019, generating around 19 800 new jobs by 2019.

SME lending

Loans to SMEs dominate in the banking sector’s lending to non-financial corporations (NFCs) as SMEs play an important role in the domestic economy of Latvia – loans to SMEs comprised 74% (at the end of2018) of total loans to domestic NFCs. The outstanding amount of banking sector loans to SMEs decreased in 2018 by 8.3%. To a large extent, this is attributed to structural changes in the Latvian banking sector (for instance, the withdrawal of the credit institution's licence). Excluding one-off effects, the SMEs loan stock did not change significantly (-1.0% year-on-year). In 2018, the new lending (flow) to SMEs was slightly higher than in 2017 (by 3.9%). Overall, the economic environment remains favourable, driven by investment growth and domestic demand. The balanced economic growth is expected to continue (the Bank of Latvia forecasts 2.9% real GDP growth in 2019) and will support credit demand.

Credit conditions

SME lending conditions remained favourable as a result of the accommodative stance of the European Central Bank and the broad-based growth of the Latvian economy. In 2018, the spread between interest rates on small and large loans continued to decrease (by 0.1 percentage point) as the interest rate on small-size loans to enterprises remained at their historically low level (3.8%), but interest rate on large-size loans increased slightly (2.7%).

According to the Bank Lending Survey (BLS), lending standards applied by banks to loans to SMEs have been unchanged for several years, remaining somewhat conservative. Due to their inherently higher credit risk, lending standards for SMEs are typically stricter than those for large corporates. For instance, the lender may require a personal guarantee from the owner of an SME.

Alternative sources of SME financing

On the policy side, substantial progress has been made since 2008 to facilitate SME access to finance. In 2014, the Development Financial Institution ALTUM was established. It is a one-stop-shop where SMEs can apply for European, national and local aid in the form of financial instruments (loans, guarantees, equity instruments, etc.). Latvia has been very active in using available EU Structural Funds to prevent market failures in the financial sector and ensure that SMEs get the required investments so they can grow. Since 2008, a variety of financial instruments have been created to facilitate the availability of financial resources in all stages of business development, especially for starting up a business. In 2018, additional financial products were launched, including three acceleration funds, while three more venture capital funds begin operations in 2019.

Government policy response

Access to finance continues to be problematic for many SMEs in Latvia. The most common limiting factors for SMEs seeking financing are insufficient collateral or warranty, as well as excessively high interest rates and costs.

The government’s focus is to bridge the finance gap for companies along different stages of development, thereby enhancing opportunities for SMEs to grow. One of the main reasons for state interventions is to produce a critical mass to foster the market’s self-development without distorting competition and crowding-out private investment.

State aid programmes for SMEs are implemented by ALTUM - a national, specialised development financing institution created in 2014. ALTUM merged three government agencies that were responsible for the implementation of programmes during the previous programming period – the Latvian Guarantee Agency, Altum (formerly Lavijas Hipotēku un Zemes Banka) and the Rural Development Fund. State aid programmes are co-financed by the EU private investors. In 2007-13 and 2014-20, additional funds were allocated to the state budget for the implementation of financial instruments.

Credit guarantees

Introduced by ALTUM, credit guarantees serve as collateral for obtaining loans from commercial banks. Active between 2009 and 2016, the programme successfully addressed market failures by issuing 564 credit guarantees totalling EUR 158 million, at an average interest rate of 0.4%. The programme has been reintroduced for the programming period 2016-20 and between 2016 and December 2018, 394 such credit guarantees were issued, for total value of EUR 69 million.

While there are no formal restrictions pertaining to SMEs, credit limits and maturity periods vary between SMEs and large firms, and within large firms as well. Guarantees are limited to 80% of financial services for both large companies and SMEs. Certain activity restrictions (e.g. financial and insurance activities, alcohol trade, etc.) as well as sectoral restrictions, per EU regulation, apply as well in terms of credit guarantees.

Portfolio guarantees were developed in 2017 to improve the availability of financial resources for small, medium and micro enterprises in Latvia. They were intended to contribute to the creation of new companies, expansion of existing activities and increase of lending rates. These portfolio guarantees will be extended to entrepreneurs through portfolio guarantees and as of the end of 2018 59 portfolio guarantees were issued attributing 3 million EUR.

Export credit guarantees

Short-term export credit guarantees insure companies against the economic and political risks of export transactions with deferred payment periods of up to 547 or 730 days. 210 such credit guarantees were issued to firms between 2009 and 2016, for a total of EUR 18 million. The scope of the programme was expanded for the current programming period, and between 2016 and 17, 49 short-term export credit guarantees were issued to firms for a total funding amount of EUR 3.06 million. Since May 2017, long-term export credit guarantees have been introduced.

Venture capital funds

Over the 2007-2013 period, various venture capital funds were introduced into the market. In 2010, the European Regional Development Fund and Latvian government financed pre-seed and seed funds for an amount of EUR 10 million. As of October 2016, EUR 7 million was invested in 80 companies. The funds provide unsecured loans at a 6% interest rate in quasi-equity and equity investments. Since market failures in early stage financing for innovative companies continue to exist, new venture capital instruments are being designed for the 2014-2020 period. These include acceleration funds that provide financial support of up to EUR 250 000 and non-financial support such as mentorship and access to industry experts/partners/next round investors.

The private sector has also contributed to venture capital funding. As of October 2016, EUR 4.8 million was invested in 9 companies. New, privately financed venture capital funds will continue to be introduced in 2014-20 and the first investments of the new programming period have already been made.

Growth capital was invested in new and innovative businesses, and the development of operational and export-oriented companies. The first growth-capital fund was introduced to the market in 2010, and made 15 investments, totalling EUR 19 million. In 2013, three new funds with a total portfolio size of EUR 44 million were launched. Of the EUR 44 million, EUR 35.7 million has been invested in 82 firms. New growth capital funds will be introduced into the market in 2014-2020.

Mezzanine loans

A mezzanine loan is a subordinate loan with low collateral requirements that is typically issued alongside a bank loan. Latvia has a mezzanine loan programme whose aim is to promote the availability of commercial bank co-financing for financially-needy projects. From 2011, when it was introduced, until October 2016, 28 such loans were issued for a total of EUR 14 million. From 2016 until December 2018, 10 loans were issued for a total of EUR 4 million. During this time, new sector and operations restrictions were introduced to the programme, such as restricted funding for companies engaging in weapons and ammunition trade, electricity and heating, etc. and other sectors prohibited by EU regulations. There are no restrictions, however, based on firm size.

Start-up loans

Commercial banks are reluctant to finance start-ups due to their high business risks, lack of financial records, the prevalence of information asymmetries between start-ups and banks, and high administrative costs of servicing loans to smaller firms. The government set up the start-up loan scheme in 2009 to address these issues. 1 585 start-up loans have since been issued under the programme for a total funding amount of EUR 24 million. Start-ups loans were financed by the European Social Fund, European Regional Development Fund, ALTUM and the state. In the 2007-2013 programming period, start-up loan interest rates ranged between 2.8 to 5.4%. From 2016, until December 2018, 400 start-up loans were issued, totalling EUR 9 million.

Micro-loans

Given that commercial banks are not very active in the micro-lending segment, a state support programme was introduced in 2007. During this time, various micro-lending programmes were introduced. On July 2014, ALTUM contracted Ltd.”Grand Credit” and Ltd.”Capitalia” to implement such a programme. ALTUM itself issued microloans in addition to these two firms. Since the launch of the partnership in 2014, EUR 14 million has been lent through 1 550 micro-loans, and more such programmes are slated for introduction in 2014-20. From 2016, until December 2018, 118 micro-loans were issued by the European Regional Development Fund and ALTUM, totalling EUR 1.5 million in funding.

Figure 27.1. Trends in SME and entrepreneurship finance in Latvia

Source: See Table 27.3.

Statlink

Table 27.3. Source and definitions for Latvia’s Scoreboard

Indicator	Definition	Source
Debt
Outstanding business loans, SMEs	Total outstanding loans to domestic NFCs (SME)	Financial Capital and Markets Commission
Outstanding business loans, total	Total outstanding loans to domestic NFCs	Financial Capital and Markets Commission
Share of SME outstanding loans	calculation	..
New business lending, total	Banking sector newly granted and newly allocated loans to domestic NFCs	Financial Capital and Markets Commission
New business lending, SMEs	Banking sector newly granted and newly allocated loans to domestic NFCs (SMEs)	Financial Capital and Markets Commission
Outstanding short-term loans, SMEs	Banking sector loans to SMEs with residual maturity <1 year	Financial Capital and Markets Commission
Outstanding long-term loans, SMEs	Banking sector loans to SMEs with residual maturity >1 year	Financial Capital and Markets Commission
Share of short-term SME lending	calculation
Non-performing loans, total	Banking sector loans to NFCs past due over 90 days	Financial Capital and Markets Commission
Non-performing loans, SMEs	Banking sector loans to SME, past due over 90 days	Financial Capital and Markets Commission
Interest rate, SMEs	Banking sector loans, proxied by interest rate on loans < EUR 250 000 (new business)	Latvijas Banka
Interest rate, large firms	Banking sector loans, proxied by interest rate on loans < EUR 1 000 000 (new business)	Latvijas Banka
Interest rate spread	calculation	..
Non-bank finance
Venture and growth capital	As proxied by Alternative investment funds.	Financial Capital and Markets Commission
Venture and growth capital (growth rate)	As proxied by Alternative investment funds.	Financial Capital and Markets Commission
Leasing and hire purchases	Financial leasing is a loan for the purchase of equipment meant for long-term use and similar fixed assets, if the lessor leases such fixed assets to the lessee for a fee that covers payments of the loan principal and interest. At the end of the lease period the right of ownership transfer to the lessee. Data covers resident non-finacial corporations leasing.	Central Statistics Bureau
Factoring and invoice discounting	Factoring is a loan for financing the working capital of an enterprise or a financial institution, whereby the factoring company acquires accounts receivable (claims) of such enterprise or financial institution by taking over the enterprise's or financial institution's right of claim on receivers of goods or services and assuming credit risk. Data covers total portfolio of factoring and invoicing.	Central Statistics Bureau
Other indicators
Bankruptcies, SMEs	Total number of bunkruptcies is provided.	LURSOFT database
Bankruptcies, SMEs (growth rate)	calculation	..

References

Bank of Latvia data.

The Financial and Capital Market Commission.