To date, the Financial Stability Board has not identified “material and persistent negative effects on SME [small-medium enterprise] financing in general” due to Basel III “although there is some differentiation across jurisdictions.” Banks are the primary providers of external SME financing, hence the reforms that are most relevant and have been implemented to date are the initial Basel III capital, leverage, and liquidity requirements agreed upon in 2010.
The definition of what constitutes an SME varies by financial institution and by country. In the U.S., according to Moody’s Analytics:
- Micro enterprises are defined as businesses with less than $1 million in annual revenue, and loan sizes up to $250,000. These businesses are serviced primarily by the branch network.
- Small businesses are defined as those with approximately $20 million or less in revenue or $1 million or less in exposures. These businesses tend to be serviced by the business banking group.
- Middle-market organizations tend to be defined as those with aggregate loan exposure between $1 million and $20 million. They are typically serviced by the commercial banking or enterprise banking groups.
The FSB consultative document ‘Evaluation of the effects of financial regulatory reforms on SME financing’ released today, did find some evidence that “the more stringent risk-based capital (RBC) requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at the most “affected” banks (i.e. those least capitalized ex ante) relative to other banks.” However, according to FSB Vice Chair Klaas Knot, “these effects are not homogeneous across jurisdictions and they are generally found to be temporary. This conclusion, which is subject to additional analysis, is consistent with the literature on the effects of bank capital regulations and with stakeholder feedback that SME financing is largely driven by factors other than financial regulation.” FSB’s research also found “some evidence for a reallocation of bank lending towards more creditworthy firms after the introduction of reforms, but this effect is not specific to SMEs.”
The FSB evaluated the Basel III reforms using qualitative and quantitative information. “Other G20 reforms that may be relevant for SME financing but are at an earlier implementation stage (e.g. Basel III reforms finalized in December 2017, accounting standards) are only reviewed qualitatively, given the lack of data required for a quantitative assessment. In addition to the G20 reforms, national and regional regulations (e.g. stress tests) may affect SME financing. Consistent with the FSB evaluation framework, these reforms have also been analyzed qualitatively.”
Bank lending, whether to the SME owner or the business itself, remains the prevalent form of SME financing in all of the FSB’s jurisdictions. Yet, there are significant differences across jurisdictions in the type of banks that typically provide SME financing. The FSB found that in many jurisdictions, larger banks, both Globally Systemically Important Banks (G-SIBs), Domestically Important Banks (D-SIBs )and others – are the main providers of SME lending in Australia, Brazil, France, Hong Kong, Italy, Korea, Mexico, the Netherlands, South Africa, Singapore, Turkey, and the US. According to the FSB “small lenders often have an important market share.”
In my experience, what hurts lending to small-medium sized enterprises far more than bank capital and other Basel III regulations are systems and processes at banks. According to an analysis conducted by Moody’s Analytics, “Although small business loans constitute more than a quarter of the lending volume in the US, most banks do not have effective systems and practices to accurately and efficiently assess small business risk and seamlessly conduct lending activities.” Importantly, Moody’s research also found that “Small businesses also face a unique set of challenges that make the process of getting credit difficult, including:
- Lack of knowledge of their credit risk and how they can improve their business credit standing.
- Opacity of banks’ credit assessment process and expectations.
- Inconsistent requirements among banks in terms of the lending process, necessary data, and documentation.
- Difficulty in maintaining current and accurate financial reporting due to manual processes and lack of expertise.
During a Financial Stability Board roundtable on December 2018, the group of representatives from the G20 found a possible impact of the post-crisis financial reforms on the provision of SME financing through non-bank financial institutions and capital markets. “It was noted that the growth in alternative financing is particularly evident in a few jurisdictions (e.g. China, UK, US).” Participants at this roundtable also noted that “there may have been some substitution effects (disintermediation) between banks and other financing providers, with the latter increasingly attracting institutional funds in search for yield.”
In the report released today, some of the G20 participants “expressed concern that banks may have increased the pricing and the proportion of secured SME lending – as well as reduced credit to riskier firms – including as a result of the reduced eligibility of collateral (both intangibles and physical collateral) for regulatory capital purposes. In that context, some participants raised the question of whether regulation strikes the right balance in terms of overall financing structure needs of SMEs.” As part of its desire to collect more data and information, the FSB is soliciting comments from the public about the effect of financial reforms on SME; the deadline is two months from now, Wednesday, August 7, 2019. Interested parties may send their views to the FSB at this address.
Source: Basel III Rules Have Not Hurt Lending To Small-Medium Enterprises
By Mayra Rodriguez Valladares, Contributor
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