Basel 3.1 – Understand the regulation
In this series of short articles, our Prudential Regulation Consulting team delves into the implications of Basel 3.1 changes on banks.
Removal of the SME support factor
IndustriesFinancial ServicesBanking & Capital MarketsPrudential supportUnderstanding Basel 3.1Basel 3.1 – Understand the regulation
Removal of the SME support factor
The PRA intends to remove the CRR SME supporting factor under the Standardised and IRB approaches to credit risk. This discount factor was introduced to limit disruption to the flow of credit to SMEs when stricter requirements were introduced after the Global Financial Crisis, in 2008.
With this scheme, lenders can apply a discount of 15% or 24% to qualifying exposures of corporate and retail SMEs. Risk weights for unrated corporates that qualify as SMEs can currently be discounted from 100% to either 85% or 76%. For retail exposures, risk weights can be discounted from 75% to 64% or 57%. The split in RWA under the SME support factor is defined by the size of the exposure, with SME exposures under €2.5mn receiving the lower RWA treatment.
With the implementation of Basel 3.1, the PRA proposes a new risk weight treatment for unrated corporate SMEs, lowering the risk weight to 85% (previously 100%). Similarly, for retail SMEs, the transactor exposures approach will cause risk weights to range between 45% and 112.5%. Thus, the PRA argue that retaining the SME support factor would result in a ‘doubling up’ effect and imprudently low-risk weights for some SME exposures. This contrasts with the ECB which leaves the underlying SME risk weights unchanged (100% for Corporate SMEs and 75% for retail SMEs) but keeps the SME supporting factor.
Given the lower underlying risk weights proposed by the PRA for Corporate SME lending, the removal of the SME support factor will have a smaller upwards capital impact than firms may have initially feared. However, there is significant divergence between the PRA and ECB over Retail SME lending and Retail Transactors (this category will cover exposures such as credit facilities and commitments to SMEs). UK firms lending to Retail SMEs are now at a clear disadvantage compared to their European counterparts from a cost of capital perspective.
Get in touch
If you have any further questions regarding Basel 3.1, please contact us via the button below and a member of our team will be in touch.
Pillar 2
The PRA has disclosed that they intend to review the Pillar 2 capital framework by 2024 at the latest. It is worth noting that these timelines are incredibly tight when aligned with the planned implementation of Basel 3.1 on 1 July 2025.
Disclosures and Regulatory reporting
Under Basel 3.1, firms are classified based on a range of criteria, such as retail deposits, total assets, derivatives, complexity, or processes.
Key contacts
Freddie Blake Associate Director – Financial Services Consulting
