Starting in 2014 with the implementation of the European Commission Capital Requirement Directive, banks operating in the Euro area were benefiting from a 25% reduction (the Supporting Factor or "SF" hereafter) in their own funds requirements against Small and Medium-sized enterprises ("SMEs" hereafter) loans. We investigate empirically whether this reduction has supported SME financing and to which extent it is consistent with SME credit risk. Economic capital computations based on multifactor models do confirm that capital requirements should be lower for SMEs. Taking into account the uncertainty surrounding their estimates and adopting a conservative approach, we show that the SF is consistent with the difference in economic capital between SMEs and large corporates. As for the impact on credit distribution, our difference-in-differences specification enables us to find a positive and significant impact of the SF on the credit supply.
While small and medium-sized enterprises are a key driver of growth in Europe, they depend heavily on bank credit for external financing and are more likely to face bank financing problems than large companies. However, in a context of tighter banking regulation and increased capital requirements (“CR” thereafter) for banks, banks' lending decisions have also become more sensitive to the regulatory framework. Thus, in 2014, the transposition of the Basel III rules into EU law introduced a 24% reduction in CR for SME exposures, referred to as the Supporting Factor (“SF” thereafter). This new regulatory tool assumes that such a reduction in CR should stimulate the supply of credit to these firms. Nevertheless, a necessary condition for the SF to be effective is that regulatory CR should be consistent with the underlying credit risk of SMEs.
The first part of this article is therefore dedicated to an examination of the consistency of this reform with respect to the intrinsic risk of SMEs. We make this assessment through the calculation of banks' economic CR (as opposed to regulatory CR) after adapting the formula of the structural credit risk framework of Basel II/III, which only recognizes a single risk factor (ASRF), to a multifactor framework that considers several risk factors, depending on the size of the firm. The results of the calculation of these economic CR based on this multifactor framework and its comparison with the regulatory CR of Basel III indicate that CR should be lower for SMEs than for large firms. On the one hand, the largest companies are the most exposed to systematic risk, i.e. to general economic conditions, even if their default rates are low. On the other hand, the results confirm the diversification potential provided by the presence of SME exposures in the total bank loan portfolio. While the medium and large enterprise classes are highly correlated with each other, the correlations are negative or very low between the small and medium/large enterprise classes. More specifically, after taking into account the uncertainty surrounding these estimates and adopting a conservative approach, the magnitude of the SF-induced reduction in CR is indeed consistent with the difference in economic CR between SMEs and large firms.
The second part of the paper is devoted to the evaluation of the effectiveness of the reform on the supply of credit to SMEs, estimated by differences-in-differences. We exploit an SF eligibility condition to define a treatment group composed of eligible exposures of SME-bank pairs with total outstanding amounts below EUR 1.5 million and a control group composed of (ineligible) exposures of other SME-bank pairs. Our results show that eligible exposures increased by 5% to 10% on average compared to ineligible exposures after the implementation of the SF (compared to before the reform). We also find that the magnitude of the SF effect increased over time to reach a magnitude of 8% to 10% two years after its implementation (see Figure below). Regarding the heterogeneity of the impact, the effect of the SF appears to be much larger on eligible exposures of small firms and, in particular, micro firms, on exposures of SMEs without credit ratings, as well as on eligible exposures classified as small. Indeed, given that the total outstanding loan portfolio is subject to the SF reduction, but also determine the eligibility for the SF, banks may have an incentive to limit the growth of exposures that are close to the eligibility threshold.
Updated on: 12/15/2020 18:13