How Might Basel III Hurt Small Businesses?
There’s a good chance you’ve probably never heard of Basel III. But as a small business owner, you should be aware of the impact that these new banking regulations could have on your ability to obtain the capital you need to grow your company.
Basel III is a set of banking regulations that places stricter standards on the nation’s banks with regard to the levels of capital they must maintain. The regulations are designed to improve both the quantity and quality of capital that banks must hold in reserve by enforcing higher capital ratios on banks. In addition, the regulations redefine core (or Tier 1) bank capital and restructure bank liabilities and risk management.
The regulations also introduce new liquidity requirements for banks via a liquidity coverage ratio and a net stable funding ratio. The primary goals are to increase capital holdings and improve liquidity, since illiquidity was one of problems banks encountered during the global financial crisis.
What All This Means to Small Businesses
OK, you might be thinking, “But what does all this have to do with my small business?” In short, many experts believe that the Basel III regulations will decrease credit availability for small businesses, while simultaneously making small business credit more expensive for companies that can obtain it.
“Basel III will increase the cost of raising capital for all small businesses,” says Bob Sloan, founder and managing partner of S3 Partners, which provides market-leading technology solutions, services, and software to banks. “And it raises the cost of buying and holding debt and equity instruments for investors that want to own a piece of a small business.”
Small banks—which have traditionally focused heavily on serving and making loans to small business—could be hit especially hard by Basel III, many experts say. This is because the higher capital ratios and compliance costs, as well as the resulting higher cost of capital, will impact small banks disproportionately.
In fact, some are predicting that hundreds, or even thousands, of small banks could be forced to shut down due to the Basel III regulations. With the phase-in of the new Basel III capital requirements set to begin in January, nearly 200 small banks still have not yet built their capital levels up to adequate Basel III levels, according to a recent analysis conducted by SNL Financial.
How Basel III Might Impact Lending
The potential impact of Basel III on small business lending could take several different forms. First, the regulations force banks to assign higher risk weights to small businesses, thus requiring even higher levels of capital to support small business loans. As a result, banks will be less inclined to make loans to small businesses.
Second, banks that do continue to make small business loans will likely limit their loan product offerings to “cookie-cutter” loans that offer no flexibility to the bank to customize the loan to a small business’ unique needs. And third, if there are fewer small banks that even exist to provide small business loans, this will make small business loans scarcer and more expensive.
“If it’s harder for banks to make loans to small businesses, and there are fewer banks in the marketplace to make these loans, this will negatively impact credit access and growth potential for small businesses,” says Sloan of S3 Partners. “And the ripple effect will be slower overall economic growth in the United States.”
Many bankers argue that a much better approach than the one-size-fits-all mentality of Basel III would be regulations with standards that vary based on complexity and risk, rather than a bank’s size. Also, they point out that regulations need to take into consideration the fact that as economic conditions improve, the needs of both banks and small businesses will change.
In other words, regulations that are effective today probably won’t be effective in a growing economy. Only time will tell if the Basel III regulations help to prevent another global financial crisis — or cause significant harm to small business growth and job creation and the broader U.S. economy overall.
