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
The 2007–2008 ﬁnancial crisis revitalized economists’and policymakers’interest 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
SMEs’access to borrowingare effective.
The adequacy of banks’capital 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 banks’resilience [Bair, 2015;
Basel Committee on Banking Supervision (BCBS), 2009; Kahane, 1977]. Nonetheless, the
quantity and quality of bank capital during the 2007–2008 crisis proved insufﬁcient 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 signiﬁcance of credit crunches for SMEs (Angelini
et al., 1998;Panetta and Signoretti, 2010;Sharpe, 1990), and the 2007–2008 crisis restored it to
prominence. SMEs suffer a more difﬁcult 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
managers’incentives 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 signiﬁcantly 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 ﬁndings suggest that the 2007–2008 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 ﬁnancial
characteristics that distinguish MSMEs in Italy and a weak bargaining power as compared to
large ﬁrm in their bank relationship have made the relationship with banks more complex and
have made it even more difﬁcult for ﬁrms in difﬁculty to meet their ﬁnancial needs. The high
level of leverage, which increased further during the ﬁnal ﬁnancial crisis and the lack of
diversiﬁcation of sources of ﬁnance, makes MSMEs very vulnerable and subject to ﬁnancial
stress that does not help them. The unchanged downward trend in business loans that has
characterized the period 2011–2019 (Bank of Italy, 2019) suggests that the credit crunch
remains the main problem for Italian MSMEs.