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EBA Report Summary: SMEs and SME Supporting Factor

Core Content

This report by the European Banking Authority (EBA) evaluates the impact of the SME Supporting Factor (SME SF) introduced in the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD IV) on SME lending in the European Union (EU). The SME SF was designed to reduce capital requirements for SME loans, thereby encouraging credit flow and improving lending conditions. The report also examines the riskiness of SMEs over the full economic cycle and assesses the consistency of capital requirements with SME risk and lending trends.

Main Findings

1. SMEs in the EU Economy

• SMEs are a vital component of the EU economy, representing a significant share of employment and value added.
• They are heavily dependent on bank financing, such as credit lines, overdrafts, and loans, for their operations.
• Alternative financing sources like equity finance, capital markets debt, and securitisation are less commonly used, often through public support schemes.

2. Lending Trends and Conditions

• The financial crisis significantly impacted SME lending, leading to a reduction in loan volumes from EUR 95 billion in mid-2008 to approximately EUR 54 billion in 2013/2014.
• Despite some recovery, SME lending has not returned to pre-crisis levels.
• Lending conditions for SMEs have worsened post-crisis, with higher interest rates and tighter collateral requirements.
• The interest rate spread between SME loans (under EUR 1 million) and larger NFCs increased from 0.89 percentage points to 1.34 percentage points since 2009.
• Bank lending to SMEs remains more constrained compared to large firms, with SMEs facing more obstacles in accessing finance.

3. Riskiness of SMEs

• SMEs exhibit a cyclical pattern in riskiness, with higher default rates during downturns and lower during upswings.
• Small enterprises are generally more risky than large firms throughout the cycle, while medium-sized firms show lower risk.
• Systematic risk (i.e., asset correlation) increases with firm size, as observed in Germany, France, and Ireland.
• The current capital requirements reflect this difference in asset correlations between SMEs and large firms to some extent.

4. Impact of SME SF

• The SME SF introduced a capital discount of 0.7619 in January 2014 to reduce capital requirements for SME loans.
• This led to an increase in the CET1 capital ratio by approximately 0.16 percentage points (weighted average), with an even greater impact on credit risk-weighted assets (RWAs).
• The application of the SME SF reduced the minimum required capital by about EUR 11.7 billion by Q3 2015.
• The impact of the SME SF on smaller banks not included in the EBA reporting sample varied across countries, often being more significant than for EBA reporting banks.

5. Empirical Analysis of SME SF

• The EBA conducted two empirical studies to assess the SME SF's effects:

  • The first study found no significant improvement in SME access to finance relative to large firms.
  • The second study evaluated the consistency of capital requirements with SME riskiness, showing mixed results:
    • The SME SF is consistent with the lower systematic risk of SMEs in the SA and IRBA corporate exposure classes.
    • However, in the IRBA retail exposure class, the SME SF may lead to undercapitalisation compared to large corporates.

• No empirical evidence supports the EUR 1.5 million amount owed limit used for SME SF application, as it may not capture the broader SME segment.

Key Recommendations

1. Continued Monitoring and Reassessment of SME SF

• The EBA recommends ongoing monitoring of the SME SF to understand its impact on SME lending.
• A repeated assessment of the SME SF's impact on lending and consistency with riskiness is necessary.
• Additional data, particularly from the SAFE survey, could provide further insights.

2. Comprehensive Review of Risk Weights

• A more comprehensive approach is needed to review risk weights for SMEs rather than applying a fixed discount.
• The EBA suggests that a "supporting discount" should be applied at the end of the capital calculation process, not affecting risk weights.
• This would avoid undercalibration in certain exposure classes, such as IRBA retail loans.

3. Review of the Amount Owed Limit

• The EBA recommends further analysis of the EUR 1.5 million amount owed limit.
• It should be compared with the EUR 1 million retail threshold and justified based on its purpose.
• The additional burden on institutions to identify and monitor this threshold should be assessed.

4. Harmonisation of SME Definition in the CRR

• Harmonisation of the SME definition in the CRR is essential to improve data availability and relevance.
• Currently, SMEs are defined differently across institutions, leading to inconsistent data.
• Legislative changes are needed to implement this harmonisation, which would improve the monitoring of SME lending, riskiness, and the impact of the SME SF.

Conclusion

• The SME SF has not significantly improved SME access to finance compared to large firms.
• While the SME SF may be justified in certain exposure classes, its overall consistency with riskiness and lending trends remains inconclusive due to data limitations and the recent introduction of the measure.
• The EBA believes that a longer period of observation is needed to fully assess the SME SF's impact.
• The report emphasizes the importance of harmonizing SME definitions, improving data collection, and ensuring that capital requirements are consistent with risk profiles.