Review of Capital Requirements UEAPMEs comments
on the 3rd Consultative Document issued by the European Commission

22nd October 2003

We acknowledge the QIS 3 results. which show a significant reduction in the banks’ capital requirements for retail loans to SMEs. We also note that the implications of the new framework for SMEs very much will depend on the discretion of supervisory authorities.2 % of the overall regulatory retail portfolio) would have discriminated SME-retail customers of smaller banks. timetable): We understand the Commission’s goal to apply the capital regulations to all European banks irrespective their size (otherwise there would be competitive distortions in the European banking market). We are concerned that different supervisory interpretations could have an indirect impact on SME and corporate finance and therefore a distorting effect on competition. We urge the Commission to pay due respect to the Parliaments demands and suggestions. This has to be taken account through lower risk weights. Besides the default of a loan to a SME does not endanger the Committee’s main priority. If the European banks (incl. Also it is questionable that the retail . since it will be the customers. 2. a further reduction of administrative burdens and a simplification of the framework should be achieved. In any case the positive elements already achieved for SMEs (esp.-21. small and medium-sized ones) have to bear large administrative burdens caused by Basel II. Concerning the current discussions about Basel II (USA. and in general a slight reduction of the capital requirements for loans to SMEs. this could lead to disadvantages of the European economy in its competition with US companies. We welcome the significant progress regarding the treatment of loans to SMEs that has been achieved in the negotiations in the Basel Committee in the last two years. We very much welcome that the Commission has deleted the 0. Therefore we think it is necessary that further alleviation. The proposed treatment of loan exposures to SMEs of up 1 Mio € as retail exposure is an improvement for many loans to SMEs even compared to the existing capital regulations. incl.2-criterion from it’s proposal. which is enhancing the stability of the banking systems. the favourable risk weights in the retail segment) should be non-negotiable. Timetable: A better Basel II is more important than a strict adherence to an inflexible timeframe. The required use test for retail loans could be a hindrance for a wide application of the retail loan category to loans to SMEs. But we are also concerned that the implementation costs in the banking sector could compensate much of the achievements made on behalf of SMEs. SMEs. Introductory Remarks UEAPME supports the Basel Committee's and the Commissions goal of strengthening the stability of the global and the European financial system. UEAPME welcomes the Initiative Report by the European Parliament (“Radwan-report”) in which the Parliament raises many important issues with regard to SME financing. who will have to bear the costs. Retail loans A preferential treatment for loans to SMEs is fully justified since portfolio and diversification effects in a bank’s loan portfolio reduce the bank‘s risk. The granularity criterion which was proposed for the standardised approach in the QIS 3 Technical Guidance (no aggregate exposure to one counterpart can exceed 0.

Therefore it should be clarified in the directive that loans to SMEs in general can qualify as retail (if the exposure does not exceed 1 Mio Euro). if there is a low risk and low default rate. this could increase the pro-cyclical effects of the new framework. otherwise it will decline in real terms. 12 on the end) . We welcome the Commission’s intention. The threshold for retail loans (1 Mio €) has to be adjusted to inflation on a regular basis. 80 %). This demand is also supported by the European Parliament (see Radwan report. If the authority decides to increase the risk weights for retail loans in an economic downtrend. since in the EU there is a clear definition of small businesses (see Commission recommendation on the definition on micro. In the IRB approach risk weights for SMEs above the retail threshold should be lower and nearer the retail risk weights. since according to the current proposal it will up to the Commission to decide whether to foresee an adjustment. but a mere delegation to the comitology is not sufficient. Taking into account the low risk of small loans to a bank’s stability we would prefer a deletion of this aspect. e. We therefore think it is necessary that the directive itself foresees an adjustment. In the standardised approach supervisors may determine higher risk weights for retail exposures (Annex C-1. Since the justification for the preferential treatment of smaller loans to SMEs is the diversification and therefore lower risk in the bank’s loan portfolio. This could lead to mis-understandings in the EU-context. This would also prevent a “cliff effect” (large difference in risk weights for loans of up to 1 Mio € and slightly above 1 Mio €). and delegates just the method of calculation to the comitology procedure. Firm size adjustment for SMEs in the corporate loan segment We welcome the approach to prevent negative effects for SMEs whose loan volumes exceed the retail threshold by taking into account their revenues (firm size adjustment in the corporate portfolio. The conditions for increasing risk weights for retail loans by the authorities in the standardised approach should be described much more precisely. 1 Mio € will be less in real terms than at the end of the consultation period (autumn 2003). small and medium-sized enterprises. According to the Basel proposals the retail segment is restricted to "small business".-3segment requires an estimation of all parameters (not only PD.g. 3. to make this adjustment possible. An increase in risk weights of retail loans by the authorities should happen only in exceptionally circumstances. We propose a special risk weight in the standardised approach for non-retail loans to SMEs with sales of up to 50 Mio €. OJ L 124 (2003). but also LGD and EAD) which means de facto that for the retail segment only the advanced IRB approach and not the foundation IRB approach is available. SME-portfolio) but we think that this firm size adjustment should not be restricted to the IRB-approach. which should be between the 75 % for retail loans. Besides. p 36). 8). it should also be able to lower it. we doubt whether these two restrictions to the application of the retail segment are really necessary. and 100 % for not-rated corporates (the risk weight should be near the risk weight for retail loans. Already in the end of 2006 when Basel II finally gets into force. if the supervisory authority is able to increase the risk weight.

factories. e. Collateral A wide-ranging recognition of SME-typical collateral is necessary: Progress has been made. the Basel Committee. requirement of stress tests).1. Besides.g. We miss a statement similar to the Basel Committee’s 3rd Consultative Document.g. An increase in risk weights of corporate loans by the authorities should happen only in exceptionally circumstances. 5. that there are no restrictions on the type of eligible guarantors: In some member countries of the EU (like Italy and France) mutual guarantee societies play an important role in SME finance. E.3). supervisory and monetary authorities on this question has to be continued.g. 7. if the authority decides to increase the risk weights for corporate loans in an economic downtrend. they can also increase risk weights for corporates in the case of individual banks. if the supervisory authority is able to increase the risk weight. this could increase the pro-cyclical effects of the new framework. these kind of financing support for SMEs should not be made obsolete or put at a disadvantage through Basel II. . E. Procyclical effects We still think that the stronger focus on the creditworthiness of companies could enforce cyclical downtrends in an economy. but we appreciate that both the Basel Committee and the Commission have addressed these concerns (e. it should also be able to lower it. The conditions for increasing risk weights for corporate loans by the authorities in the standardised approach should be described much more precisely. but the rules are still too restrictive. But see also for instance various Working Papers published by the BIS. Therefore.g. most of them foresee cyclical effects. the flexibility should be extended to the foundation IRB. work by the Commission. The requirement of periodic inspection by the bank of inventories that are collateral is a dis-incentive for banks to accept this kind of collateral. Corporate loans in the standardised approach: Supervisory authorities can increase the risk weight for not-rated claims to corporates “when they judge that a higher risk weight is warranted by the overall default experience in their jurisdiction” (Annex C-1. and opinions expressed by a variety of experts.-4It will be important that all the thresholds (for retail loans and the SME-segment) will be adjusted to economic growth and inflation on a regular basis. in the case of „commercial real estate„ the term „multi-purpose„ excludes many kinds of real estate that is used by businesses. 4. par 445. More flexibility concerning the criterions that a guarantee should be non-cancellable and irrevocable is necessary.

This would also reduce possible negative effects on venture finance. business angels. (In the current proposal it is in the discretion of supervisory authorities to decide what commercial real estate exposures are qualified as HVCRE) Maturity In some member states long term loans play an important role in corporate finance. We welcome the proposed firm size adjustment for equity investments. Equity The proposed treatment of equity has to be improved significantly. In our view it is important that the new capital adequacy framework takes into account the differences in corporate finance that can be observed in the EU member states. If a better solution for business start-ups is not achievable in the framework of the Basel II accord. simple risk weight method: 300 % for publicly traded companies. We propose to create a retail segment also for equity investments (with more favourable risk-weights for smaller equity investments compared to larger investments) – both in the standardised approach and in the IRB approach. 6. HVCRE should be restricted to large and very risky commercial real estate projects. because otherwise their financing condition could worsen under Basel II. 400 % for all other equity holdings) . tax measures). since this term causes some confusion and concern among our members. innovation and change in an economy. We therefore welcome the more flexible approach (for the retail segment supervisors can substitute a figure of up to 180 days).-5Business Start-ups Since newly created enterprises can demonstrate no rating history when applying for a loan. IRB. that other instruments supporting the creation of new enterprises have to be developed or improved (like mutual guarantee schemes. but think such a flexibility is also necessary for non-retail exposures to SMEs. The proposed risk weights for equity investments seem to be much too high (e.g. otherwise we are concerned that there will be negative effects on the European venture capital & private equity markets. venture capital. Start-ups are crucial for the dynamic. Default definition According to the proposed default definition. Specialised Lending High-volatility Commercial Real Estate (HVCRE) We ask the Commission to define more clearly what HVCRE is. The default definition could be to the disadvantage of certain businesses since this could heighten the PD for them. We therefore welcome the current approach concerning maturity. all involved parties have to make clear. a default takes place when the obligor is past due more than 90 days on any credit obligation. we think that there should be special rules for this companies.

are transparent vis a vis the SME. In matters that are delegated to the comitology. that claims on certain PSEs with revenue raising powers are treated as claims on the sovereign in whose jurisdiction the PSE is established (Annex C-1. Also there has to be a reasonable approach concerning operational risk. We welcome the commitment of the Basel Committee that the aggregate level of regulatory capital in the banking system should not increase due to the new regulations. 8. it will be important that all interested parties (not only banking associations) have the opportunity to bring in their expertise and opinions and that there will be also consultation periods that give sufficient time for deliberation and discussion. 3. transparency of rating In general it is important. otherwise bank lending could become more expensive for SMEs. Frankfurt. smaller ones) can implement an Internal Rating based System without disproportionate costs. Comitology procedure With respect to the complexity of the regulation and the fast changing world of financial services we understand the need to delegate technical matters to the comitology procedure. Public Sector Entities (PSEs) As proposed by the Basel Committee (3rd Consultative Document. We also support the European Parliaments demand for a draw back clause. For SME customers of banks it is important that that the criteria. . since that aspect reduces the room for banks to give loans to companies. conducted by the Hochschule für Bankwirtschaft.-6See also Background Paper on the Consequences of Basel II for SMEs. for the European Parliament (presented in the EP’s workshop on Basel II on July 10th): according to that study the proposals do not consider the higher influence of the financial institution on the management of the SME (provision of managerial expertise which reduces risk). 7. under which a SME is rated. Banks obligations under Basel II.1). From Europe’s SME’s point of view we welcome the proposals in pillar 3 (Market discipline) concerning the transparency of rating systems. The relevant criteria affecting the rating of the SME should be transparent at least to the SME itself when it is seeking and negotiating a loan. The rating system of a bank should not be a “black box” for the SME customer. Par 32) it should be possible subject to national discretion. that banks (incl.