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

Purpose – This analysis asks whether regulatory capital requirements capture differences in systematic risk for large fi rms 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 fi nd 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 considering default risk of loans to MSMEs and distortions in capital charges between MSMEs and large fi rms under the Basel III framework. The authors compiled fi rm-level data to capture the proportions of MSMEs and large fi rms in Italy during 2000–2014. The data set is drawn from fi nancial reports of 708,041 fi rms over 15 years. Unlike most empirical studies that correlate assets and defaults, this study assesses a fi rm’s creditworthiness not by agency ratings or by sampling banks but by a speci fi c model to estimate one-year probabilities of default. Findings – The authors found that asset correlations increase with fi rms’ size and that large fi 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 signi fi cantly with turnover. This analysis showed that the regulatory supporting factor represents a valuable attempt to treat MSME loans more fairly with respect to banks’ capital requirements. Basel III-internal ratings-based approach results show that when the supporting factor is applied, the Risk- Weighted-Assets (RWA) differences between MSMEs and large fi rms increase. Research limitations/implications – The implications of this research is that banking regulators to make MSMEs support more effective should review asset correlation estimation criteria, re fi ning the fi tting with empirical evidence. 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 de fi ned 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 and regulatory capital charge remains high. When the authors examined the Basel III-IRBA, results showed that when the supporting factor is applied, the RWA differences between MSMEs and large fi rms increase. This is particularly strong for loans to small- and medium-sized companies. Correctly calibrating asset correlations associated with the supporting factor eliminates regulatory distortions, reducing the gap in capital charges between loans to large corporate and MSMEs.