Germany drops objections to Basel II after SME solution

Germany lifted its objections today to the Basel II bank Accord, welcoming a compromise on lending to small businesses that will be discussed next week by global banking regulators.

German chancellor Gerhard Schröder told a news conference in Berlin that Germany’s aim of preventing the Basel II bank capital adequacy Accord leading to more expensive loans for its small and medium-sized business enterprises (SMEs) had been met, Reuters news agency reported today.

Schröder, who faces elections in September, had threatened to veto the complex and much-delayed Basel II pact if it penalised bank lending to SMEs, regarded in Germany and other countries as a key factor in economic growth.

“My impression is that… a result can be achieved which is in the interests of the German Mittelstand (SMEs),” he said today. “There will not be any general increase in the cost of financing for Germany’s Mittelstand…..I think it’s a good result for us all,” he added.

Experts with the Capital Task Force, the senior sub-grouping of the Basel Committee, finalised a solution in Stockholm last month (see RiskNews story). This will now go for approval at the full Basel Committee’s quarterly meeting next week in Basel, Switzerland.

The solution centres on allowing banks to set aside on average 10% less protective capital against loans to smaller businesses than they will against loans to large corporations. Many loans to SMEs will be treated like retail loans to consumers as opposed to corporate loans.

The justification for the solution is the view that while a loan to any individual small business is generally riskier than that to a large corporation, the pattern of SME and retail credit risk is less volatile, and therefore more predictable, than that for large corporate loans.

This is because a portfolio of loans to a large number of SMEs is likely to be more diversified than one concentrated in loans to a handful of large companies, as Basel Committee chairman William McDonough told German businessmen in May.

The lower volatility and greater diversification would validate lower capital charges because the loss rate is more stable, regulators said.

The risk-based Basel II Accord will determine from late 2006 how much capital major banks will have to aside as a protective cushion against losses from the risks of banking. The Basel Committee on Banking Supervision, the architect of Basel II, is the body that in effect regulates international banking.