Credit constrained firms and government subsidies: evidence from a European Union program

BIS Working Papers  |  No 984  | 
01 December 2021



Globally, small and medium-sized enterprises (SMEs) have patchy access to finance. Due to the important economic role of these firms, especially as employers, governments subsidise and support SMEs generously. Research has shown that subsidies help SMEs to grow in size. However, it is not well understood if subsidies take effect by making credit more available, or by cutting the cost of funding. Moreover, it is also not obvious if a subsidy-led growth in assets will translate into higher sales, profitability or productivity. On the one hand, if a firm has good investment ideas but cannot obtain financing due to a short credit history (eg young firms) or the lack of collateral (eg small firms), then a subsidy can help it overcome a relevant constraint. On the other hand, if the firm has no worthwhile projects or is poorly managed, the credit constraint may simply reflect these other shortcomings, which subsidies may not help resolve.


This paper uses a unique combination of data sets (including the credit register) from Hungary to help fill these gaps in the literature. A novelty of our approach is that we directly identify credit-constrained firms – ie businesses that applied for a loan but were refused. Classifying firms as credit-constrained (CC) and not constrained (NC) is the key to disentangling the two channels through which subsidies can work. It also helps to assess if CC firms benefit more or less from subsidies than do NC firms.


We show that subsidies do lead to a significant incremental lift in the asset growth of CC firms relative to that of NC firms. Since subsidies provide both groups with cheap capital, the incremental effect shows that an "easing of the financial constraint" channel is at work for CC firms. However, this effect fades after a few years. Moreover, we find no incremental effect on broader measures of firm performance. This suggests that banks may be less willing to lend to such firms for valid reasons concerning their future prospects and credit risk. Thus, on average, a lack of funding does not seem to be keeping SMEs behind, at least in Hungary.


We assess the effects of non-repayable subsidies on financially constrained and unconstrained Hungarian SMEs. Using rejected subsidy applicants as control group and bank queries to the credit-registry to identify firms that applied for but did not receive a loan, we show that subsidies generate a sizeable incremental impact on asset growth of constrained firms relative to unconstrained businesses. This effect, however, is transitory and does not translate into higher sales, profitability or productivity. Financing, therefore, may not be the primary hurdle for these SMEs, and credit constraints may reflect other shortcomings, such as lack of good management or viable projects.

JEL classification: G38, G21, E58.

Keywords: SMEs, subsidies, credit constraints, emerging market economies, difference-in-differences, credit registry micro-data.