What is good and bad with the regulation supporting the SME’s credit access
Date | 01 May 2020 |
Pages | 569-586 |
DOI | https://doi.org/10.1108/JFRC-10-2019-0132 |
Published date | 01 May 2020 |
Author | Pietro Vozzella,Giampaolo Gabbi |
Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
What is good and bad with the
regulation supporting the SME’s
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 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 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 firms under the Basel III framework. The authors compiled firm-level data to capture the
proportions of MSMEs and large firms in Italy during 2000–2014. The data set is drawn from financial
reports of 708,041 firms over 15years. Unlike most empirical studies that correlate assets and defaults, this
study assesses a firm’s creditworthinessnot by agency ratings or by sampling banks but by a specific model
to estimateone-year probabilities of default.
Findings –The authors found that asset correlations increase with firms’size and that large firms 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 significantly with turnover. This analysis showed that the regulatory supporting factor
represents a valuable attempt to treatMSME loans more fairly with respect to banks’capital 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 firms increase.
Research limitations/implications –The implications of this research is that banking regulators to
make MSMEs support more effectiveshould review asset correlation estimation criteria, refiningthe fitting
with empiricalevidence.
Practical implications –The asset correlation parameter stipulated by the Basel framework is
invariant with economic cycles, decreases with borrowers’probability of default and increases with
borrowers’assets. The authors found that those relations do not hold. This way, asset correlations fall
below parameters defined by regulatory formula, and SMEs’credit 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 firms
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 effective. Any remaining errors, misrepresentations, and omissions are our own.
Regulation
supporting the
SME’s 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 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.
JFRC
28,4
570
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