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  • Will the competition regulator level the prudential playing field? Posted on 20 October 2015

    Ahead of Thursday’s publication of the provisional findings of its long-running investigation into the supply of personal current accounts and of banking services to small and medium-sized enterprises, the Competition and Markets Authority (CMA) has today published further materials on SME lending.

    In a submission prior to the provisional findings, Lloyds Bank argues that the CMA needs to recognise the importance of alternatives to conventional bank loans. In 2014 it points out, there was £26 billion of new business leasing and hire purchase, compared to £24 billion of new term loans. It goes on to note that only 17% of asset finance agreements are made with the bank holding the business current account.

    Meanwhile a new summary of a hearing held with the Prudential Regulation Authority (PRA) usefully debunks the theory that smaller banks are at a major disadvantage to their larger competitors when it comes to capital requirements regulations for SME lending.

    True, banks normally need five years’ historical data and three years of model usage to get their risk models approved for the ‘internal ratings based approach’ (IRB) to calculating capital requirements that could give them an advantage over smaller banks stuck on the ‘standardised approach’. However, the PRA points out, the larger banks who are able to benefit from IRB calculations are also likely to be hit by higher capital requirements due to minimum capital buffers, which are increasing.

    Overall, the capital requirements for larger banks are likely to be higher than for smaller banks. So although the capital requirement for a marginal loan will be greater for a bank on the standardised approach than one using the IRB, this doesn’t leave the large bank at quite such an advantage as might first appear. (Of course this doesn’t work for the marginal loan, but there’s a limit to how long any bank can carry on treating every deal as marginal).

    The hearing was told that the PRA is at an early stage of exploring the extent to which it could be made more feasible for new entrants to develop IRB models. One way the PRA might consider achieving that is to encourage or require sharing of granular historical loan performance data across the market. The primary drivers of losses in asset finance must be the customer and asset characteristics, not anything specific to the individual bank.

    Make this data available to new banks and they should be able to develop reliable IRB models sooner rather than later. Alternatively achieve the same result by allowing a more favourable treatment for asset finance under the standardised approach, based on shared industry-wide data as already exists in other asset finance markets including those in Italy, Canada and the USA.  

    Requiring the sharing of detailed probability of default and loss given default data across the market must be one of the key tools available for improving competition in the market. Perhaps this will be on the list of possible remedies the CMA will publish on Thursday, assuming its provisional findings report concludes there are indeed issues in the SME lending market.

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