Bankers Recognize the Need for Investment in Digitalization, but Not for Intangible Guarantees

Digitalization of business and the application of artificial intelligence (AI) are now a necessity, and this trend is particularly important in the context of the Croatian economy, where low productivity is one of its long-standing issues. According to the political program ‘Digital Decade’ adopted by the European Commission, by 2030, the European economy should achieve three goals in digitalization: the first goal is that at least 75 percent of European companies introduce cloud computing services, big data processing, and artificial intelligence into their operations; the second is that more than 90 percent of small and medium-sized companies reach at least a basic level of digital intensity (a measure of the use of various digital technologies at the entrepreneurial level); and the third is to double the number of unicorns, companies valued at over one billion dollars.

Progress Better than EU Average

In the report on the state of the digital decade published by the European Commission in September, in the chapter on Croatia and the achieved level of digitalization of the economy, it is noted that last year, local companies achieved slightly better results than the European average. However, the potential for digitalization of small and medium-sized companies is still underutilized. This problem was also highlighted at the Digital (R)evolution conference organized by the HUP Association of Information and Communication Activities (HUP ICT) held at the end of November. Namely, as many as 1,200 companies in Croatia need to digitalize to a very high level if we want to reach the EU average, it was heard at that gathering. In other words, to achieve this goal, domestic companies would need to use six or more different technologies, and more than four thousand implementations would be necessary, noted HUP ICT president Hrvoje Balen at the conference.

Systematic investment in business development is crucial for achieving business results and productivity growth, assesses the chief economist of the Croatian Chamber of Economy (HGK) Goran Šaravanja.

– In the manufacturing industry, it is important to be technologically modern, especially in an era where the general shortage of adequate labor raises labor costs, which implies prudent and systematic investment regardless of the size of the company. These trends affect the service sector, where technological advancement has enabled even greater access to data. However, processing and using that data in business development and discovering business opportunities also requires investment in appropriate systems, says Šaravanja.

However, when it comes to the application of artificial intelligence, the Croatian economy does not stand so poorly. An analysis signed by HGK and Best Advisory states that every other Croatian company uses some AI tools, most often in the field of data analytics, chatbots, or virtual assistants and process automation. The CroAI association states that artificial intelligence should be introduced into all areas of society.

– With timely education and demystification, the share of artificial intelligence usage will only grow, they assess in CroAI.

The potential of artificial intelligence in increasing productivity is also shown by the latest research from the Nielsen Norman Group based on three case studies (for customer service, writing routine business documents, and coding a smaller software project), which concludes that the use of generative AI in business improves user performance by 66 percent. Such an increase in productivity is equivalent to a 47-year natural increase in productivity in the US and an 88-year growth in Europe.

Slowing Down of Investment Loans

Of course, money is needed for investments, and for the majority of domestic entrepreneurs – regardless of size – banks are the first address when it comes to capital. If we look at the dry statistics, less and less money is being allocated for these purposes. According to the latest data from the Croatian National Bank, the growth of loans to companies has continued to slow slightly as a result of the base period effect. Specifically, a slowdown in growth of investment loans has been recorded from 9.6 to 8.1 percent. The director of the Croatian Banking Association (HUB) Tamara Perko emphasizes that the lower growth rates of loans to companies compared to previous periods, when inflation was rising, are precisely related to the gradual slowdown of the inflation rate.

– Part of the previous credit expansion was related to rising prices of investment goods and inventories, and now that effect is gradually weakening. However, real loans are still slightly increasing, which is in line with the continuation of economic growth in Croatia. Economic growth will crucially affect the demand for loans in the coming year, and growth expectations at this moment are positive. If the existing trends in the sectoral distribution of loans to companies continue, we can predict that loans will continue to be directed primarily to industry, trade, tourism, and recently to the energy sector, as banks contribute to the energy transition, explains Perko.

When it comes to banks’ willingness to finance investments in digitalization and broader use of artificial intelligence, Perko says that it is certainly a type of placement that is interesting to banks because financially stable companies with moderate risks lead such investments.

New Announcements Only from HAMAG

Regarding investment loans in the SME segment, the largest growth of 13.8 percent was achieved in 2022, while in 2023 it slows to a minimal 1.4 percent according to HNB data for the end of October, says the director of 3D Business Finance Vesna Jurković.

– The greatest support for the investment cycle of the SME segment from June 30 last year to today is the Croatian Bank for Reconstruction and Development, with the NPOO program and direct financing of investments. Commercial banks have significantly slowed this part, claims Jurković.

According to her, HBOR, considering existing capacities and the fact that it is the most desirable provider of investment loans today in the financial market, is under significant pressure. This is yet another obstacle to the implementation of the investment cycle of Croatian companies.

– On the other hand, there is a visible growth of 13 percent compared to 2022, in investment loans to large companies, those with more than 250 employees and revenues exceeding 50 million euros. However, this segment is also slowing down; last year’s growth rate was 25 percent, notes Jurković.

New announcements in the domain of investment financing come only from HAMAG, adds Jurković, and relate to loans mostly intended for micro-enterprises, up to one hundred thousand euros with a part of non-repayable principal. Since this is an announcement, not an actual program, it is questionable how much of this effect will be felt in business in 2024 in the amounts of loans allocated to entrepreneurship.

Problem with Material Coverage

When asked whether there are specialized credit lines for investment and digitalization, Vesna Jurković emphasizes that they can be found in HBOR, but also in commercial banks.

– It is positive that the mindset of traditional bankers has changed, and investment in intangible assets, which digitalization is, except for investments in hardware, is increasingly recognized. However, a key problem arises in the implementation of financing, the material coverage of such investments. Namely, although there are programs and guarantees for investments in digitalization, they are implemented with great difficulty because they require sufficient material coverage from entrepreneurs, which is often not possible, emphasizes Jurković.

There are excellently tailored guarantees, such as InvestEU, EIF guarantees for innovation and digitalization specifically for this purpose, but commercial banks require material coverage due to the pari passu model, notes this analyst.

– With HBOR’s NPOO program, it is also possible to finance investments in digitalization, but without satisfactory material coverage, it will not be possible. Intangible assets are still not a basis for banks to register a mortgage, and traditional banking recognizes only real estate as adequate material coverage and, to a lesser extent, equipment and business shares. A potential change in recognizing the value of digital solutions as satisfactory coverage for investments in digitalization is difficult to achieve in traditional banking, but that is precisely why there is room for improving financial levers such as tailored guarantee schemes applicable in terms of satisfactory material coverage for such investments by commercial banks, says Jurković.

Not Expensive as One Might Think

Therefore, investments in digitalization are currently most supported by grants in the form of non-repayable funds that are part of the digitalization project, while larger investments need to be secured by the entrepreneur from their own operational cycle. Large companies also have access to the capital market to raise money for investments. Accordingly, the Zagreb Stock Exchange expects increased interest in raising capital as the era of cheap money is behind us, and capital may be needed more than ever.

– The freedom for business and company development provided by financing in the capital market practically has no alternative. This is clear to all developed economies. The continuous growth of deposits testifies that capital is there; it just needs to be mobilized. We have seen this in the case of government bonds intended for citizens. Digitalization is no longer the future; it has long been our reality, and it can certainly improve company performance and thus bring added value to owners. It is reasonable to expect that investors would see their interest in such investments, assesses the president of the Management Board of the Zagreb Stock Exchange Ivana Gažić.

In the research by HGK and Best Advisory, it states that 32 percent of respondents do not use AI nor plan to use it in the future due to the costs of implementation. The CroAI association emphasizes that the costs of applying artificial intelligence in business are not nearly as high as people think, and the profitability can be much greater. It is time for Croatian entrepreneurs to become aware of this.