The Relationship between SMEs and their Banks

Small and medium-sized entities (SMEs) are the backbone of the Maltese economy as they comprise the largest category of businesses in terms of number of enterprises (99.8%), employment generation (81%), and value added (80%). Furthermore, they contribute towards the growth of our economy in terms of value added (at 4.8%) and employment (at 11.4%). Banks provide loans to 85% of SMEs within the European Union, signifying their fundamental role in providing SME financing. SMEs are often heavily reliant on this finance route to fulfil their start-up, cash flow and investment needs, although it also has its own drawbacks.

Malta transposed Directive 2013/34/EU, commonly referred to as the Single Accounting Directive, into national legislation through the adoption of General Accounting Principles for Small and Medium-Sized Entities (GAPSME) and amendments to certain provisions in the Companies Act. GAPSME is the default financial reporting framework that SMEs, upon qualification of certain criteria, are obliged to abide by for financial reporting periods commencing on or after 1 January 2016, unless the company directors resolve otherwise.

The Three Domains
The Three Domains

This article is an abstract of a study entitled “GAPSME: Cause for Concern from a Bank Lending Perspective?” carried out through semi-structured interviews conducted in January 2017 with six of the leading local financial institutions. This research seeks to identify whether the simplification of financial reporting brought about by GAPSME will impact access to local SME financing. It will briefly delve into the present lending procedures adopted by banks for SMEs and whether these will change once the new accounting framework is in force.

Information used by Local Banks when Granting Credit

Financial statements constitute the basis of decisions throughout the whole lending process, and banks still request their clients to provide financial statements in all instances; for new or existing lending facilities, and new or active clients. Some local banks charge clients a fee or higher interest rates when financial statements are not presented to them on time as a cover for the higher risk involved, however financial statements are still required before granting or extending the loan to the SME.

This study also identified that local banks perceive the Statement of Cash Flows to be the most important element of the financial statements. Cash flow management is key for a business to ensure success as poor cash flow management, rather than low profitability, is the primary reason for a vast proportion of business failures.

A notable observation which emanated from this research is that banks believe that sole reliance on financial statements gives an incomplete view of the client. Banks require information about the client’s internal structure and its operations, financial analytics, and future projects the client intends to undertake. Malta is a small community with close-knit relationships and banks also place reliance on knowing the client. This is also probably due to the fact that most of the SMEs are owner-managed businesses without distinctive separation between management and the business itself.

On a final note, in certain borderline cases, when the client is temporarily in financial difficulty, banks occasionally use a multi-tier credit approval process with the collaboration of the credit and risk departments as well the board of directors. This ensures greater accountability and lowers the possibility of bad decision-making. This form of dual or multi-tier approval levels is resorted to by two-thirds of the respondents; the other two banks did not disclose information.

Will Local Banks’ Attitude towards SME Lending change as a Result of GAPSME?

When the GAPSE reporting framework was introduced, banks were apprehensive about the simplification of financial statements. Some bank representatives felt that simplified accounting standards could impact their risk assessment, whilst others were of the view that even though financial reporting is more specific and disclosures under IFRSs exceeded those under GAPSE, no financial reporting framework can address all issues.

As a result of the adoption of the Single Accounting Directive into our legislation, small companies using GAPSME will not be required to prepare the Statement of Cash Flows for statutory purposes. This will only be required for medium-sized entities. When interviewed, bank representatives replied that previously, under the GAPSE reporting framework, they asked for additional financial and non-financial information during the evaluation process. All the respondents stated that they will continue to ask for more information, even if this mean loss of clients.

GAPSME is now the default framework and this is also coupled with the fact that thresholds for determining small and medium-sized entities have increased. Therefore certain companies which previously were required to apply the IFRS framework will now change to GAPSME. This will result in changes in the measurement bases for certain assets and liabilities. Therefore local banks will need to revisit their covenants, such as gearing, debt-to-equity and debt service coverage ratios.

Local Banks
Local banks’ attitudes and approach towards GAPSME Financial Statements

All in all, the general sentiment is that local banks are willing to continue conducting business by extending credit to SMEs. However, they are of the opinion that if clients want to develop a sound lending relationship with them, they must:

  • Abide by the banks’ terms and conditions,
  • Cooperate by presenting all requested documents or information lacking in the financial statements, and
  • Ensure that their house is in order.

Clients requiring support from banks must therefore embrace the notion of cooperation and increased financial information requirements, if they want to increase their chances of obtaining finance or nurture a long-term trustworthy relationship with the bank.

The Banks’ Views of the Way Financial Reporting by SMEs can be Improved

Further to the above, the study sought out to find out the banks’ views on ways that SMEs can improve the probability of obtaining finance. The following points were mentioned:

  1. Historical vs Prospective Information – Local banks believe that previous performance does not guarantee similar future results, therefore projections are preferred to historical information. The assessment of new projects should ideally be placed on reliable projections, made after the bank evaluates the assumptions on which such projections are based.
  2. Cost vs Fair Value Measurement Bases – Local banks provide mixed reactions to their preferred measurement basis. The most important factor is that the measurement basis should be clearly identifiable in the financial statements, regardless of the fact that banks perform their own valuations.
  3. GAPSME: Microenterprises and Disclosure – The preparation of financial statements can be the most cumbersome process for microenterprises amongst SMEs. The majority of local banks do not consider client size as a factor that affects the extent of information required in their analysis, therefore they will continue to request for all the required information regardless of size.


The general sentiment of local banks is that the approach towards SME lending will not be affected by the accounting framework as the final decision on whether to extend credit is not solely determined on financial statements. Locally banks are willing to accept GAPSME, if clients present additional information prepared by diligent entrepreneurs.

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