The European Union and many of its individual member states are working on ways to improve SMEs’ access to working capital on the understanding that small businesses are the backbone to economic strength and employment. These efforts are largely fueled by the impacts of the economic crisis, which forced banks to adopt more stringent lending rules. SMEs saw higher interest rates, if they were approved for a bank loan at all.
Today, alternative funding is viewed by many as the remedy to SMEs’ weakened access to working capital, though some research shows that banks are relaxing their lending behaviors.
New proposals by the Basel Committee on Banking Supervision, however, could introduce a new wave of SMEs unable to access working capital from a traditional financial institution. Experts agree that, if approved, the Basel regulations would have widespread effects on the banking sector and the SME community throughout the jurisdictions that adopt them. Just what those effects are, however, are unclear, and are likely to vary from country to country. The Basel Committee’s proposals are likely to harm SMEs that depend on banks to access capital, but they may also boost the alternative lending markets in nations that embrace the industry.
Startups are viewed as high-risk for lenders. The Basel Committee’s recent proposals, which were published last month, are calling for banks to add a 300 percent risk weight for SME loan applicants. The proposals also call for a 300 percent risk weight to be applied to applicants that are unable to provide necessary information on risk factors, which is largely understood to refer to SMEs.
According to the British Bankers’ Association, the varying rules across jurisdictions mean that many SMEs are exempt from filing public documents that would provide this risk information.
The BBA, which published its own response to the Basel Committee’s recommendations just days later, said that while it supports a more risk-sensitive approach to bank lending, it is also questioning whether these proposed reforms are “a solution without a problem,” noting that not all asset classes have any obvious problems at present.
Further, the BBA argued, the Basel Committee’s rules will likely have far-reaching effects, especially for SMEs. “It is quite conceivable,” the BBA wrote, “that some categories of business would become uneconomic for banks.” This not only would heighten barriers to entry for new, smaller banks, but highlights a renewed perception that SMEs are unprofitable for lenders.
Instead, the BBA suggested that banks should apply a combination of behavioral and financial data when assessing the risk factor for applicants, providing a more accurate overview on a case-by-case basis and bypassing the varied standards for financial statement data seen within different jurisdictions.
Overall, the BBA said, the Basel Committee’s proposals for SMEs lending could lead to “potentially very damaging impacts.”
While some experts fear that the Basel recommendations would once again make it increasingly difficult for SMEs to access working capital from a bank, the BBA did point out one consequence of these rules: “Unsatisfied lending demand could be met by the shadow banking sector with the implication that counterparty exposures will be less visible to the regulatory community,” the group wrote.
While the BBA framed this as a negative consequence, a heightened barrier to bank loans could force regulators to revamp efforts to establish alternative lending regulations, bring alternative lending out of the “shadow” economy, and provide a viable alternative to bank lending for SMEs.
The U.K., research shows, has an especially robust alternative lending sector, though recent research shows that half of U.K. SMEs are unaware of their alternative lending choices. As businesses there continue to struggle with late payments, U.K. lawmakers have just enacted new rules that would force banks that reject an SME applicant to refer that company to an alternative lender.
One supporter of the U.K.’s Alternative Business Funding Portal, Adam Tavener, recently told reporters that while he does not support the Basel’s new bank lending proposals, they could inadvertently work in favor of the alt-lending community. “If enforced, it will clearly increase the number of small businesses declined for finance by the banks and, as a result of the referral system, these will be re-directed to alternative funding providers,” he said.
The EU and the U.S., both participating member nations in the Basel Committee, are also working toward establishing alternative lending regulations to promote small business lending,
For participating member nations of the Basel Committee without a robust alternative lending market, local SMEs could bear the brunt of the negative impacts foreseen by the BBA. While the European Commission is working toward facilitating cross-border crowdfunding rules, some individual member states have adopted restrictions on these alternative lending choices. For example, Germany recently revealed new regulatory proposals that would force startups looking to raise $2.7 million or more to disclose investment risks, though SMEs in the nation offered their support of the rules because they offered “a functioning framework for crowdinvesting,” according to German Startup Association chairman Florian Nöll.
Similarly, Italy recently launched its own crowdfunding rules. But according to analysis from Moody’s, nearly all of SMEs will be ineligible to receive financing from crowdfunding platforms. “Only 7,000 out of a total 3.7 million SMEs are potentially eligible under the new rules,” which specify that only innovative SMEs can receive these funds, said Moody’s vice president Monica Curti in a recent report.
While it is unclear just what, exactly, the impact of the Basel Committee’s proposals would be – or if they will be adopted by participating member nations at all – has yet to be seen. But as some experts anticipate potentially damning effects for SME lending, the proposals could inadvertently support growth and development of alternative lending, if national regulators act quickly.
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