Bank Capital after the Global Financial Crisis: “Collateral Damage” for SMEs
Can peer-to-peer lending offer a silver lining?
The Global Financial Crisis which began in mid-2007 had led to a spate of regulatory reforms. Basel III was developed in response to the deficiencies in financial regulation and is aimed to strengthen bank capital by introducing new regulatory requirements on bank liquidity and leverage. While the global banking sector had only just been implementing Basel II, the trend is towards embracing a more stringent bank capital management regime. In the bond markets, bank issuers and investors alike are already evaluating capital adequacy ratios harmonized on Basel III standards.
Treatment of SME loans
An OECD report highlights that the effect of Basel II and III is that banks will be incentivised to economize on capital and expand business into lower risk-weighted areas.
Individual and SME loans which are largely un-rated will attract the highest risk weight of 75%-100%, compared to large and better-rated companies (20%) or sovereigns (0%). These loans are also considered to be illiquid and will attract a liquidity coverage ratio of 100%, meaning that for every $1 the bank dishes out in loan, it must raise $1 of liquid assets. Taken in tandem, these restrictions significantly increase the cost of making such loans for the bank. Hence, the corollary would be (i) a reduction of bank lending to retail and SMEs and/or (ii) high or sticky loan rates to compensate for the higher cost of capital.
In Context: Singapore
In Singapore, the effects of bank deleveraging have been documented in the MAS Financial Stability Review 2012. Although deleveraging is mainly by Euro-zone banks who were most affected by the crisis, notwithstanding the fact that they account only for less than 7% of non-bank credit to residents in Singapore, concerns remain over the curtailment of credit to finance trade and business activities. This is because while well-capitalized Singapore banks have been filling in the void, the increasing number for constituents demanding a slice of banks’ balance sheet and their zealous quest to maintain the pristine ratings of being the World’s Safest Banks (“gold plating”) inevitably means that the extension of credit will have to be rationalized. In fact, Mr Piyush Gupta, CEO of DBS had estimated that fast-forward five years, the region as a whole will be short of capital somewhere between a quarter of a trillion to a trillion dollars. [link]
Now, if the CEO of one of the World’s Safest Banks is saying so, one could foretell that our SMEs’ slice to the funding pie will be capped if not constrained. It is hard to imagine that SMEs will be getting any improvement nor latitude in loan terms from banks. Hence, the prospect of increased access to friendly bank financing remains dim for SMEs. I’m afraid there is little light at the end of the tunnel for SMEs in the traditional banking system.
 OECD (2012), Financing SMEs and Entrepreneurs 2012: An OECD Scoreboard, OECD Publishing.http://dx.doi.org/10.1787/9789264166769-en