What is good and bad with the regulation supporting the SME’s credit access

Pages:569-586
SUMMARY

Purpose This analysis asks whether regulatory capital requirements capture differences in systematic risk for large firms and micro-, small- and medium-sized enterprises (MSMEs). The authors explore whether bank capital regulations intended to support SMEs’ access to borrowing are effective. The purpose of this paper is to find out whether the regulatory design (particularly the estimate of asset correlations) positively affects the lending process to small and medium enterprises, compared to large corporates. Design/methodology/approach The authors investigate the appropriateness of bank capital requirements... (see full summary)

 
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What is good and bad with the
regulation supporting the SMEs
credit access
Pietro Vozzella
Department of Management and Law, University of Siena,
Siena, Italy, and
Giampaolo Gabbi
SDA Bocconi School of Management, Milan, Italy
Abstract
Purpose This analysis asks whether regulatory capital requirements capture differences in
systematic risk for large rms and micro-, small- and medium-sized enterprises (MSMEs). The authors
explore whether bank capital regulations intended to support SMEsaccess to borrowing are effective.
The purpose of this paper is to nd out whether the regulatory design (particularly the estimate of asset
correlations) positively affects the lending processto small and medium enterprises, compared to large
corporates.
Design/methodology/approach The authors investigate the appropriateness of bank capital
requirements consideringdefault risk of loans to MSMEs and distortions in capital charges betweenMSMEs
and large rms under the Basel III framework. The authors compiled rm-level data to capture the
proportions of MSMEs and large rms in Italy during 20002014. The data set is drawn from nancial
reports of 708,041 rms over 15years. Unlike most empirical studies that correlate assets and defaults, this
study assesses a rms creditworthinessnot by agency ratings or by sampling banks but by a specic model
to estimateone-year probabilities of default.
Findings The authors found that asset correlations increase with rmssize and that large rms face
considerably greater systematic risk than MSMEs. However, the empirical values are much lower than
regulatory values. Moreover, when the authors focused on the MSME segment, systematic risk is rather
stable and varies signicantly with turnover. This analysis showed that the regulatory supporting factor
represents a valuable attempt to treatMSME loans more fairly with respect to bankscapital requirements.
Basel III-internal ratings-basedapproach results show that when the supporting factor is applied, the Risk-
Weighted-Assets(RWA) differences between MSMEs and large rms increase.
Research limitations/implications The implications of this research is that banking regulators to
make MSMEs support more effectiveshould review asset correlation estimation criteria, reningthe tting
with empiricalevidence.
Practical implications The asset correlation parameter stipulated by the Basel framework is
invariant with economic cycles, decreases with borrowersprobability of default and increases with
borrowersassets. The authors found that those relations do not hold. This way, asset correlations fall
below parameters dened by regulatory formula, and SMEscredit risk could be overstated, resulting in
a capital crunch.
Originality/value The original contribution of this paper is to demonstrate that the gap between
empirical andregulatory capital charge remains high. Whenthe authors examined the Basel III-IRBA, results
showed that when the supporting factor is applied,the RWA differences between MSMEs and large rms
increase. This is particularly strong for loans to small- and medium-sized companies. Correctly calibrating
The author thank the anonymous referees for their valuable comments and suggestions. An earlier
version of this article was read by Fergal McCann and Gabriele Sabato who were very inspiring to
make the paper more eective. Any remaining errors, misrepresentations, and omissions are our own.
Regulation
supporting the
SMEs credit
access
569
Received31 October 2019
Revised10 March 2020
Accepted24 March 2020
Journalof Financial Regulation
andCompliance
Vol.28 No. 4, 2020
pp. 569-586
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-10-2019-0132
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
asset correlationsassociated with the supporting factor eliminatesregulatory distortions, reducingthe gap in
capitalcharges between loans to large corporate and MSMEs.
Keywords Basel III, Credit risk, Capital adequacy, Asset correlations, Supporting factor
Paper type Research paper
1. Introduction
The 20072008 nancial crisis revitalized economistsand policymakersinterest in the
relation between banking regulation and credit expansion. According to Berger and Udell
(2006), credit scoring models instigate expansion of credit and investment during
expansionary economic cycles and perpetratea credit crunch during contractionary cycles.
As small- and medium-sized enterprises (SMEs) are rated using models dependent on
retrospective facts, their ability to borrow during negative cycles is below that of large
corporations. This study explores whether bank capital regulations intended to support
SMEsaccess to borrowingare effective.
The adequacy of bankscapital has been analyzed extensively since becoming the core
motive for prudential regulation. Capital adequacy covers losses through commercial banks
acceptance of credit risk, thereby protecting depositors and assuring the multiplier effect of
lending (Dewatripont and Tirole, 1993). A second reason why regulation addresses bank
capitalization is leverage-based credit and investment, which is capped by underlying capital
(Giammarino et al., 1993). Reducing leverage arguably improves banksresilience [Bair, 2015;
Basel Committee on Banking Supervision (BCBS), 2009; Kahane, 1977]. Nonetheless, the
quantity and quality of bank capital during the 20072008 crisis proved insufcient and
provoked regulation and supervision that fueled credit rationing because they were introduced
when the threat of non-performing loans seemed extreme (Fio rdelisi et al., 2017).
Economic literature has long debated the signicance of credit crunches for SMEs (Angelini
et al., 1998;Panetta and Signoretti, 2010;Sharpe, 1990), and the 20072008 crisis restored it to
prominence. SMEs suffer a more difcult access to credit than large companies because they
impose greater informational asymmetries on lenders (Berger and Udell, 1995;Degryse and
Van Cayseele, 2000). Accounting requirements for SMEs are less rigorous, mitigating
managersincentives for a detailed disclosure (Baas and Schrooten, 2006). With relative ability
of banks to access the right information and to process it appropriately, lenders may hesitate to
grant credit and insist on higher rates (Ivashina, 2009). Small businesses are dependent on
direct lenders because they suffer very limited access to public capital markets. As a result,
bank shocks can signicantly contract credit to SMEs (Berger and Udell, 2002). The European
Banking Authority (EBA) (2016) has assessed evidence for the EU, the Organisation for
Economic Co-operation and Development (OECD) (2017) for developed economies and the
European Bank for Reconstruction and Development (EBRD) (2015) for emerging economies.
Collective ndings suggest that the 20072008 credit crunch hit micro-, small- and medium-
sized enterprises (MSMEs) harder than large companies. MSMEs suffered a sharp contraction
in their borrowing from banks during the Great Recession in Italy. The economic and nancial
characteristics that distinguish MSMEs in Italy and a weak bargaining power as compared to
large rm in their bank relationship have made the relationship with banks more complex and
have made it even more difcult for rms in difculty to meet their nancial needs. The high
level of leverage, which increased further during the nal nancial crisis and the lack of
diversication of sources of nance, makes MSMEs very vulnerable and subject to nancial
stress that does not help them. The unchanged downward trend in business loans that has
characterized the period 20112019 (Bank of Italy, 2019) suggests that the credit crunch
remains the main problem for Italian MSMEs.
JFRC
28,4
570

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