Finance: Research, Policy and Anecdotes

The Financial Stability Report has just published a draft report for public consultation on the effects of Basel III on SME Finance. My former colleague and co-author Hans Degryse and I have served as academic advisors on this project. This report is part of a larger evaluation programme that also include an evaluation of the effect of Basel III on infrastructure finance (already published) and an evaluation on Too-Big-To-Fail (just starting).

Here is the summary of the findings of the consultative report: “…the analysis thus far does not identify material and persistent negative effects on SME financing in general, although there is some differentiation across jurisdictions. There is some evidence that the more stringent risk-based capital (RBC) requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at the most ‘affected’ banks (i.e. those least capitalised ex ante) relative to other banks. These effects are not homogeneous across jurisdictions and they are generally found to be temporary.” These results are not that surprising for many observers. They come on the background that regulatory subsidies such as the SME supporting factor in the EU have not really helped SME lending as well as previous findings that higher capital requirements negatively affect private second lending at most in the transition period if at all.  One important caveat to keep in mind is the heterogeneity across the different FSB jurisdictions, some of which recovered relatively quickly from the Global Financial Crisis, while others took much longer or went back into recession, while introducing regulatory reforms.  There are also significant differences in banking sector structures across banks, in terms of ownership and market structures.

While the main text might not give it away, an enormous amount of data and estimation work went into this exercise, undertaken by different teams across jurisdictions and setting an important precedent for future evaluations of regulatory reforms. Different exercises using cross-country data on the bank- or firm-level were accompanied by country-specific exercises using regulatory data for banks and credit registry data.  The latter allows for the most rigorous disentanglement of supply and demand-side effects by linking banks to firms and assess changes in lending (conditionality) over time.  While this evaluation might not satisfy the much higher causality standards adopted in the development field, it clearly shows the way forward in terms of evaluations of regulatory reforms. And important next step would be to extend the assessment of such reforms to non-FSB member jurisdiction, especially emerging markets and developing economies, as we call for in this recent task force report on Making Basel III work for the EMDEs.

Overview