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SMEs Dance to the Basel III Shuffle

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I often wonder, what if Basel II capital accords had been in place prior to the Great Recession? 
 
Could the devastating crisis fueled by the serial pops of credit bubbles rumbling through the dismal landscape of G20 principalities been avoided with better capital adequacy safeguards? 
 
Could the precious Post Cold War Peace dividend been preserved; had the fiduciaries of global solvency not toppled the dominoes of economic prosperity and political stability through extreme selfishness and irrational behavior?
 
Some economists assert that had the guidelines of Basel II been in place it would not have mattered. That may certainly be true, but one is still left to wonder if Systemically Important Financial Institutions (SIFI) had followed better governance frameworks the fissures emanating from the epicenter of the global economic meltdown would not have been as deep or as widespread.
 
The lessons learned from the crisis are being codified in the new governance frameworks of Basel III. Whereas previous Basel Accords focused on capital adequacy and loss reserves aligned to risk weighted assets and counterparty exposures, Basel III looks to strengthen capital adequacy by addressing liquidity and leverage risk in the banks capital structure. Basel III recognizes the primacy of mitigating the systemic risk concentrated in the capital structure of a SIFI and lesser designees, and the contagion threat it poses on its counterparties and the greater economy. 
 
To ally solvency concerns, Basel III installs a leverage ratio and bolsters its Liquidity Coverage Ratio (LCR) which will require all banking institutions to increase its regulatory capital reserves of High Quality Liquid Assets (HQLA). An increase in HQLA reserves will raise the cost of capital for all financial institutions requiring it to raise its spreads on credit products. 
 
SMEs will be particularly affected by Basel III initiatives. SME’s are highly dependant on bank capital and credit products and remain highly sensitive to the cyclicality of macroeconomic factors. D&B’s Small Business Health Index reports that SME business failures in the US were in excess of 140,000 per month in 2013. The OECD reported that during 2012 over 800,000 EC SME’s closed shop in 2012. 
 
Eurofact reported that 60% of all non-financial value add to the EC economy is attributable to SMEs. Though SMEs are generally recognized as principal economic drivers in both the developed and lesser developed economies; during the economic crisis SME’s were rationed out of the credit markets. Large capital infusions and accommodative monetary policy by the central bank authorities principally sought to bolster bank capital and inject liquidity into the faltering global banking system. 
 
As such much of the low cost capital provided to banks did not trickle down to SMEs. Better returns were realized by deploying capital to investment partnerships, energy resource development, the acquisition of strategic commercial enterprises and underwriting speculative trading in the global security markets. 
 
Little of the low cost capital found its way onto Main Street; driving the bifurcating wedge between the real and speculative economy. As a more conservative political landscape emerges from the wreckage of the economic calamity created by “elitist” financial institutions and “remote” Brussels based government bureaucrats, the cause of the SME is resonating in the rising voice of a middle class spoken with a distinct nationalist accent. 
 
Politicians, legislators and advocacy groups are fully invested in the cause of the SME. Stakeholders are advocating more government involvement to underwrite and guarantee sponsored loans. In an era where government involvement in markets is under severe attack, political expediency and prudent economics coalesce to fund the incubation of SMEs. Even if greater government intervention is counterintuitive to laissez faire proclivities of the politically engaged, higher taxes would be required to fund the risk of capital formation initiatives. The securitization of SME loans is also a consideration; but aversion to leverage and the risk to encourage poor lending practices raise fears of creating yet another credit bubble.
 
The Government of Singapore recently rose its guarantee on SME loans to cover 70% of principal in response to the increase in cost of capital banks will charge as a result of Basel III. Spreads on SME loans are estimated to increase between 50 to 80 basis points. This rise in the cost of capital will allow banks to recoup Basel III compliance expenses associated with the segregation of regulatory capital requirements to service SME loan portfolios.
 
The risk premia on SME loans is justified by regulators because it guarantees the availability of credit through the business cycle. The financial health of SME’s are highly correlated to the vicissitudes of the business cycle. During times of cyclical downturns risk factors for SMEs are magnified due to the prevalence of concentration risk in products, regions, markets, client and critical macroeconomic factors germane to the SME’s business. Mitigation initiatives are inhibited due to liquidity constraints, resource depletion and balance sheet limitations. The closure of credit channels exacerbates this problem and Basel III risk premia pledges to fund SMEs through a trying business cycle.
 
To maintain profitability of SME lending, banks will enhance quality standards and haircut collateral margins; a potentially onerous demand since asset valuations remain severely distressed from the effects of the Great Recession. Banks will avoid SMEs with enhanced risk profiles, make greater use of loan covenants, expand fee based services and hike origination fees to protect margins and instill enhanced credit risk controls to minimize default risk.
 
As the strictures of Basel III take root within commercial banks alternative credit channels are opening to better match an SME’s credit requirements and market situation with a financial product that best addresses their business condition. D&B has initiated a timely capital formation initiative for SMEs. Access to Capital – Money to Main Street is an event tour that is bringing together regional providers of funding for SMEs and startups. 
 
The economic recovery is combining with technology to energize innovations in SME funding options. Crowd-funding, micro-lending, asset financing, leasing, community bank loans, credit unions and venture capital channels are a few of the many options available for small business funding. Each channel offers distinct terms and advantages that match a funding option to the specific situation of an SME. 
 
SME associations and advocacy groups are surfacing in the EU that seek to harness the residual capital created by SME failures. Second Chance and Fail2Suceed are initiatives that seek to harness the intellectual capital garnered by entrepreneurs in unsuccessful enterprises. It is a clear recognition that a great failure can be the mother of greater wisdom. This may augur well for the success of Basel III as it seeks to build on the shortfalls of its forebears to better protect the global banking system as it promotes the wealth of nations by equitably funding the growth of the global SME segment.
 
Sum2 offers a portfolio of risk assessment applications and consultative services to businesses, governments and non-profit organizations. Our leading product Credit Redi offers SMEs tools to manage financial health and improve corporate credit rating to manage enterprise risk and attract capital to fund initiatives to achieve business goals. Credit Redi helps SMEs improve credit standing to demonstrate creditworthiness to bankers and investors. On Google Play: Get Credit|Redi
 
Risk: SME, Basel III, commercial lending, political stability, economic growth, USA, EU, alternative credit channels, credit risk, global banking, business failure, OECD, SIFI
This article was originally released on Daft Blogger.  
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April 14, 2014 Posted by | Uncategorized | , , , , , , , , , , , , , | 1 Comment

Davos Dithers While Cairo Burns

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In the pristine air of the Swiss Alps,  the worlds power elites gather at an annual World Economic Forum in Davos Switzerland.   In this rarefied Hall of the Mountain King’s, Prime Ministers, CEOs and the esteemed emissaries of the global elite get some valuable face-time with each other to assess the world situation and figure out ways to arrange it more to their likeness.   Russian Prime Minister Medvedev  was scheduled to give the welcoming address but had to cancel because a Chechen suicide bomber blew himself up in Moscow’s busiest airport taking a couple dozen travelers with him.

Busy looking inward to protect personal interests,  the fiduciaries of global solvency stew about regulatory overreach and the added burden it creates as the ruling elites balance the demands of worldly subsistence with the perplexities of generating sufficient cash flows to cover dividend payments to shareholders.  More often than not the heft of shareholder concerns outweighs the growing immiseration of the world’s troubled masses.  The deeply held sacred dogma that enlarged prosperity for the wealthy benefits the disenfranchised is being increasingly challenged as the wealth gap rises against a backdrop of growing economic duress and political instability.

The growing movement to topple Egyptian President Hosni Mubarak illustrates the failure of a global trickle down political economy.  Mubarak has held office since Anwar Sadat’s unceremonious removal from office  is receiving urgent signals from the Egyptians that he has clearly overstayed his welcome.  For three decades, Mr. Mubarak and his military caliphate have been the recipients of generous western aid packages designed to maintain a tenuous peace with Israel.  Stitched together at Camp David in the closing days of the Carter Administration; the sibling rivalry between Abraham’s jealous children remains incendiary and its stability will be tenuous at best considering the growing role of  The Muslim Brotherhood in challenging Mubarak’s continued rule.

The United States sends Egypt $1.5 billion in military aid each year.  Its seem a small price to pay to guarantee the peace with Zion and to  underwrite a strategic ally in the volatile Arab world.  It’s also a perfect political foil to counterbalance Israel’s favored nation status.   But US aid and IMF loans have financed Mubarak’s autocracy creating deep political fissures within Egypt.  These aid programs have widened the wealth gap by limiting opportunity to a select few; abetted political disenfranchisement that encouraged social unrest,  fueling Islamic radicalism and the urgent need for democratic reforms.

The game plan followed in Egypt for the past three decades is not working.  The nature of western aid to Egypt and how it was used to benefit the military ruling elites illustrate the conundrum of the Davos Hajiis.   Aligning economic development and political empowerment of the world’s disenfranchised with the needs of the global capitalist elites has failed to deliver on its promise.  The pursuit of Mule and  Sparrow economics have engorged the elites and left the many sparrows emaciated.

When the Davos delegates leave their ski chateaus for an afternoon on the slopes, as they exit the lifts at the top of the world, it may yet still be possible to glimpse the growing crowds amassing in Tahrir Square.  It may still be possible to connect the dots of promoting the inclusive economics of reciprocity and social democracy.  The revolutionaries gathering in Liberation Square  are joining with the dispossessed to give full voice for an agenda of change.

The elites have stored up too much wealth for themselves.  The masses have remained wanting, impoverished of goods and denied liberty, fed a steady diet of repression they stoke fires in Tahrir Square signaling the time for change has arrived.

Music selection: Edvard Grieg: In the Hall of the Mountain Kings

Risk: Middle East, political stability, economic prosperity, global economy, democracy, Egypt, Hosni Mubarak, Davos, IMF, Israel, Tahrir Square, revolution, military rule, Jimmy Carter, Mule and Sparrow Economics, Camp David Accords, Medvedev, Anwar Sadat, World Economic Forum

 

 

 

January 30, 2011 Posted by | banking, corporate social responsibility, credit crisis, democracy, Egypt, history, Israel, Middle East, military, Muslim, politics, revolution, social unrest, Uncategorized | , , , , , , , , , , , , , , , , , , , | Leave a comment