Striking the balance: De-risking and SME finance in light of Basel III

Martijn Friso Bos

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Basel III, de-risking and SME finance all were hot topics at the recent Alliance for Financial Inclusion (AFI) SME Finance Working Group (SMEFWG) and Global Standards Proportionality Working Group (GSPWG) meetings held in Kuala Lumpur last month.

Attention for global regulatory changes and their effects in emerging economies has increased since 1 January 2013 marked the beginning of the implementation period of the third Basel Accord, commonly known as Basel III. The accord was called into life as a successor to Basel II, to restrain and stabilize international financial markets in the wake of the 2008 global financial crisis. Basel III was created by the Basel Committee on Banking Supervision, which sought to ease the deficiencies that had become evident during the crisis — high leverage ratios and very low capital requirements. Over the phasing in period of 2011-2019, Basel III will impose stringent requirements on bank capital, liquidity and bank leveraging. Implementing the accord can pose a challenge even for developed capital markets, while for developing countries there is widespread concern implementation without due regard to the principle of proportionality could lead to unintended consequences that are out of step with the aims of the Basel Committee.

Although the financial crisis originated in developed economies and a longer timeline is allowed to developing countries by the Basel Committee, concern to maintain investor confidence and thus economic growth is driving many developing countries to decide on early implementation of Basel III. In that context, the AFI provides a platform for its members from developing and emerging countries to share experiences and support implementation, which is in line with proportionality in practice.

As Basel III takes hold, it could lead financial institutions to de-risk their investments, which especially in less developed markets, raises concerns that traditionally ‘risky’ investments such as that SME finance and microfinance will diminish significantly. As it stands, 70 percent of the world’s SMEs do not have adequate access to finance, with a credit gap estimated at $3.5 trillion (Source: IFC/Mckinsey Report). From the point of view of SME finance, three areas are of direct concern—capital requirements, liquidity framework and leverage ratio framework. High capital requirements can alter a bank’s willingness to offer finance to unrated, small SMEs, and liquidity frameworks mean banks would likely retain easy-to-sell credit lines rather than long-term, low-yield lines as usually extended to SME’s. Naturally, the Basel Committee does not intend to diminish economic growth by inhibiting SME’s access to finance—thus in order to achieve a balanced approach, there has been a call for proportionality in practice. Proportionality in practice is the ability for developing and emerging markets to apply international standards in a way that is commensurate with their market capacity and does not suffocate them through over-regulation. Without a proportional approach, short of ceasing operations entirely, capital constrained SMEs will need to turn to shadow banking or crowdfunding, leaving the regulator in the dark.

Building on the Basel Committee’s recognition for the need for proportionality in its revised core principles, AFI provides a platform in the Global Standards Sub-Committee comprising seven deputy governors from the AFI Network, and at the technical level, the GSPWG.

The GSPWG is developing case studies on proportionality in practice in member countries, so that emerging markets can see where their application can be proportional and yet still adhere to international standards. Currently, five AFI members are developing further studies, covering topics from the impact of tiered KYC requirements; proportionate agent banking and mobile financial services regulations; as well as proportionate policies for the microfinance and SME sectors.

It is important that Basel III is not held in a bad light solely because it places a high benchmark for financial institutions. After all, it is charged primarily with ensuring that the widespread failures in risk mismanagement by financial institutions that contributed to the global financial crisis will not happen again in the future. It is true that having to adhere to higher standards will, in many instances, lead to slower and less growth—but that growth will be stable and the key to shifting from an emerging market to a developed one. If emerging markets, through proportionality in practice, find a way to apply international standards so that they achieve the objective of greater financial stability while avoiding unintended consequences, we can together avoid castles built on sand and focus on strong foundations for a successful, sustainable future.

ABOUT THE AUTHOR
Martijn Friso Bos is a Policy Program Officer at the Alliance for Financial Inclusion.

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