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What is good and bad with the regulation supporting the SME’s credit access

Pietro Vozzella (Department of Management and Law, University of Siena, Siena, Italy)
Giampaolo Gabbi (SDA Bocconi School of Management, Milan, Italy)

Journal of Financial Regulation and Compliance

ISSN: 1358-1988

Article publication date: 30 April 2020

Issue publication date: 16 September 2020




This analysis asks whether regulatory capital requirements capture differences in systematic risk for large firms and micro-, small- and medium-sized enterprises (MSMEs). The authors explore whether bank capital regulations intended to support SMEs’ access to borrowing are effective. The purpose of this paper is to find out whether the regulatory design (particularly the estimate of asset correlations) positively affects the lending process to small and medium enterprises, compared to large corporates.


The authors investigate the appropriateness of bank capital requirements considering default risk of loans to MSMEs and distortions in capital charges between MSMEs and large firms under the Basel III framework. The authors compiled firm-level data to capture the proportions of MSMEs and large firms in Italy during 2000–2014. The data set is drawn from financial reports of 708,041 firms over 15 years. Unlike most empirical studies that correlate assets and defaults, this study assesses a firm’s creditworthiness not by agency ratings or by sampling banks but by a specific model to estimate one-year probabilities of default.


The authors found that asset correlations increase with firms’ size and that large firms face considerably greater systematic risk than MSMEs. However, the empirical values are much lower than regulatory values. Moreover, when the authors focused on the MSME segment, systematic risk is rather stable and varies significantly with turnover. This analysis showed that the regulatory supporting factor represents a valuable attempt to treat MSME loans more fairly with respect to banks’ capital requirements. Basel III-internal ratings-based approach results show that when the supporting factor is applied, the Risk-Weighted-Assets (RWA) differences between MSMEs and large firms increase.

Research limitations/implications

The implications of this research is that banking regulators to make MSMEs support more effective should review asset correlation estimation criteria, refining the fitting with empirical evidence.

Practical implications

The asset correlation parameter stipulated by the Basel framework is invariant with economic cycles, decreases with borrowers’ probability of default and increases with borrowers’ assets. The authors found that those relations do not hold. This way, asset correlations fall below parameters defined by regulatory formula, and SMEs’ credit risk could be overstated, resulting in a capital crunch.


The original contribution of this paper is to demonstrate that the gap between empirical and regulatory capital charge remains high. When the authors examined the Basel III-IRBA, results showed that when the supporting factor is applied, the RWA differences between MSMEs and large firms increase. This is particularly strong for loans to small- and medium-sized companies. Correctly calibrating asset correlations associated with the supporting factor eliminates regulatory distortions, reducing the gap in capital charges between loans to large corporate and MSMEs.



The author thank the anonymous referees for their valuable comments and suggestions. An earlier version of this article was read by Fergal McCann and Gabriele Sabato who were very inspiring to make the paper more effective. Any remaining errors, misrepresentations, and omissions are our own.


Vozzella, P. and Gabbi, G. (2020), "What is good and bad with the regulation supporting the SME’s credit access", Journal of Financial Regulation and Compliance, Vol. 28 No. 4, pp. 569-586.



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