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Fix Europe by fixing small businesses

May 6, 2013: 11:36 AM ET

The European Central Bank's move to lower interest rates won't be enough to help the small and medium-sized businesses that drive the economy in many regions.

Mario Draghi, president of the European Central Bank

Mario Draghi, president of the European Central Bank

FORTUNE -- The European Central Bank eased investor worries last week when it cut its benchmark interest rates for the first time in almost a year. Stocks around the globe soared, but the central bank stopped short of doing one thing that could really turn around the region's debt crisis: Help small and medium-sized businesses.

In Italy and Spain, among the eurozone's most troubled places, such businesses drive the economy. For instance in Spain, more than 60% of the economy and 80% of the jobs come from small and medium-sized companies – otherwise, known as SMEs.

These businesses once relied on regional savings banks, but since the financial crisis those banks aren't lending much, if at all, after years of being too easy on borrowers and operating with too little equity. Whereas Spain had 45 regional savings banks a few years ago, there are only 13 today, and even their future is uncertain.

This has become a huge problem, contributing to rising unemployment in Spain and Italy. The credit crunch has also reduced tax revenues, making it harder for the peripheral countries to bring their deficits down to manageable levels.

On Thursday, the ECB, the central bank for countries using the euro, swooped in, cutting the main refinancing rate by a quarter of a percentage point to 0.50%. The move came after a series of data released during the past two weeks suggested that the eurozone's economy shrank for the sixth quarter in a row at the start of 2013. Unemployment rose to 12.1%, while inflation fell to 1.2% in April -- well below the ECB's medium-term target of just under 2%.

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While the central bank's rate cut should provide troubled banks in the region's periphery with some much-needed support, it won't be enough to drag the eurozone out of recession on its own, says Paul Ashworth, economist at the consultancy Capital Economics.

"We had hoped that the bank might announce looser collateral criteria or other measures to stimulate lending, particularly to SMEs," Ashworth notes to clients.

To be sure, ECB President Mario Draghi has indicated the central bank may do more to keep the eurozone from falling even deeper into recession. This includes reviving lending to businesses, but those discussions are still in the very early stages. As officials figure out a plan, experts say the central bank will need to assume more risk on its balance sheet if it wants to boost lending to SMEs.

How this could be done is tricky, since banks coming off the dark days of the financial crisis are still far from fully recovered and quite risk averse. There are a few options, though: The central bank could assume some of the risks by buying SME-backed securities, or certain tranches of them, says James Howat, European economist at Capital Economics. But the thought of buying less-than-investment grade assets in bulk poses bigger credit risks than the central bank may want to take on. So it may not bode well with some members.

A less politically challenging route, perhaps, could be where either the European Investment Bank or the European Commission provides a guarantee or some form of financial cushion against losses from at least parts of the loans, says Jacob Funk Kirkegaard, senior fellow at the Peterson Institute for International Economics.

The point is that how low interest rates fall won't matter as much as any real efforts to directly boost lending to SMEs.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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