Effects of the New Basel Capital Accord on Bank Capital Requirement for SMEs

Abstract

Using data from three countries (US, Italy and Australia) and surveying related studies from several other countries in Europe, we investigate the effects of the New Basel Capital Accord (Basel II) on bank capital requirements for small and medium sized enterprises (SMEs). For each country, we analyze different possibilities that banking organizations have in considering SMEs, as either retail or as corporate, with a special discount linked to the firm's sales size. We find that, for all the countries, banks will have significant benefits, in terms of lower capital requirements, when considering small and medium sized firms as retail customers. But they will be obliged to use the Advanced IRB approach (providing their own estimates of probability of default (PD) and loss given default (LGD) for each counterparty) and to manage them on a pooled basis. For SMEs as corporate, however, the results show that capital requirements will be slightly greater than under the existing Basel I Capital Accord. We believe that most eligible banks will use a blended approach (considering some SMEs as retail and some as corporate). Through a breakeven analysis, we find that for all of our countries, banking organizations will be obliged to classify as retail at least 20% of their SME portfolio in order to, at a minimum, maintain the current capital requirement (8%). Moreover, we show that the percentage of SMEs to be classified as retail increases to at least 40% if banks will want to enjoy lower capital requirements by implementing the Advanced IRB instead of the Standardized approach. Since one of the main goals of the new Basel Capital Accord is to improve the efficiency of banks risk management systems, we conclude that a likely impact will be an additional motivation for banks to consider and manage their SMEs clients as retail customers.

Keywords: SME finance, basel II, bank capital requirements, retail banking

JEL Classification: G21, G28