Increasing the threshold for applying internal rating to boost SME lending?
The Australian government has kicked off an inquiry into the banking system. It will be chaired by David Murray the former CEO of Commonwealth Bank of Australia. A draft terms of reference has been released and a number of interested parties have commented on it.
The Commercial Asset Finance Brokers Association of Australia Limited (CAFBA) submission caught my eye as it had a specific suggestion to change the regulatory capital requirements for banks to make it easier to lend to SMEs. The CAFBA submission outlines a number of issues that potentially makes it harder for SMEs to borrow money.
APS 113 details the prudential requirements for banks who are accredited to use their internal models to calculate regulatory capital requirements. According to CAFBA, banks have more onerous requirements for loans in excess of $1m, and hence are reluctant to lend over this amount. CAFBA recommends lifting this threshold.
Loan pricing by banks vs fixed interest investors
Banks using a risk based pricing approach, charge interest rates on loans to cover:
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The cost of borrowing or funding
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Expected cost of loan default
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Expenses to service the client
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A rate of return on capital employed
Different banks will potentially charge different interest rates to the same client. The differences depend on the banks’ source of funds, the rate of return required and level of capital employed. Of course, differences in the banks’ strategies or in their view of the client’s default risk will also result in different rates being offered.
On the other hand, the investors approach to pricing assets is different. Typically an investor would discount the cash flows at a rate built up as follows:
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Risk free rate
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Expected cost of loan default
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Risk premium
SME lending – a sweet spot?
I keep reading about how viable, high quality small medium enterprises (SMEs) find it difficult to secure debt financing from banks. An OECD study of SME sector lending conditions found that credit was still constrained following the GFC. This is covered in the press from time to time, for example, see this article in the Financial Times. The situation also seems to occur in Australia according to this article in the Sydney Morning Herald. If high quality SMEs struggle to get debt funding, then surely this is a sweet spot waiting to be exploited. A SME loan fund can exploit this demand. Australia’s burgeoning superannuation sector could participate.
BCBS coming down hard on trading books
The Basel Committee on Banking Supervision (BCBS) has been ruminating on changes to prudential rules for trading activities at banks. In October of this year, BCBS released its second consultation paper. It follows the first document released in May 2013, and has definitive views of how trading books should be regulated.
The changes will be far-reaching and significant. The phrase “Fundamental Review…” in the title of consultation paper is indeed appropriate. Market risk managers need to be thinking about the proposal, and what will be required in the next few years as the changes hit. Some banks may even need to debate the value of continuing their trading activities.
Risk Return Sweet Spot 