Basel II focus switches to securitisation after SME loan solution agreed

Experts working on the Basel II bank capital rules are focusing on the technically difficult issue of asset securitisation after agreeing a solution this month to the politically sensitive problem of how lending to small and medium-sized enterprises (SMEs) should be treated under the pact, international regulators said.

The SME solution is along lines previously foreshadowed by regulators. It centres on allowing banks to set aside on average 10% less protective capital against loans to smaller businesses than to large corporations. Regulators believe the proposals will calm fears in some countries that Basel II would stifle lending to small businesses. Many loans to SMEs will be treated like retail loans to consumers as opposed to corporate loans.

With asset securitisation, technical experts are concentrating mainly on ensuring the Basel II credit risk provisions will have a neutral effect on the development of securitisation, which covers a range of techniques whereby banks can pool loan portfolios and issue new off-balance-sheet securities backed by a pool. Regulators were reluctant to discuss details of their progress at this stage.

The securitisation and SME lending issues have held up progress in implementing the complex Basel II capital adequacy Accord now due for implementation from late 2006. The risk-based Accord will determine how much of their assets major banks will set aside as protective capital to guard against losses from the credit, market and operational risks they face.

A meeting in mid-July of the Basel Committee on Banking Supervision, the architect of Basel II and the body that in effect regulates international banking, is expected to approve the SME lending proposals for incorporation into QIS3 – the third Basel II quantitative impact survey that the regulators hope to issue to banks on October 1.

QIS3 will seek information on how Basel II will affect banks and help regulators prepare their third Basel II consultative paper, which they plan to issue in May next year for banking industry comment. Basel supervisors hope to publish their final version of Basel II in late 2003, which will allow three years for national regulators and banks to ready themselves for the new capital adequacy regime.

The Basel Committee’s senior sub-grouping, the Capital Task Force, will meet immediately prior to the July full Committee meeting to finalise their proposals for the treatment of asset securitisation for approval by the Basel Committee. The Basel regulators then hope to issue a paper on asset securitisation along with QIS3 on October 1. They also plan to publish a non-technical update on progress with Basel II on the same date.

The Capital Task Force agreed last week in Stockholm on the proposals for treating bank lending to SMEs. Regulators said that while lending to any particular SME or individual consumer is generally riskier than lending to a large company, the pattern of SME and retail credit risk is less volatile, and therefore more predictable, than that for large corporate loans.

This is because a portfolio of loans to a large number of SMEs is likely to be more diversified than one concentrated in loans to a handful of large companies, as Basel Committee chairman William McDonough told German businessmen in May.

The lower volatility and greater diversification would validate lower capital charges because the loss rate is more stable. Capital charges are designed essentially to guard against unexpected rather than expected losses. But under Basel II banks will have to show their supervisors that they have budgeted adequately for expected losses, regulators said.

To be classed as an SME under the plans a firm must have sales or turnover of around E40 million ($39 million) or less. The downward adjustment of capital charges compared with those for lending to large corporations would range from virtually zero for firms with sales of E40 million to a maximum of 20% for firms with the lowest turnover.