New rules on bank accounting led to a 15-20% fall in banks’ SME lending between 2018 and 2020, according to new research by Aytekin Ertan, Assistant Professor of Accounting. He also warns that the implications for the post-COVID-19 period – when thousands of businesses are likely to be seeking financial support - could be detrimental for the wider economy.
These tighter regulations (known as IFRS 9) were introduced at an international level in the wake of the 2008 financial crisis to try and make the financial sector more resilient to swings in the economic cycle. The ultimate aim was to protect national economies - and the taxpayers who picked up so many of the costs – arising from the extremes of bank lending, which helped to precipitate the 2007-08 crisis.
However, despite policy makers’ good intentions, the new rules are having far-reaching and unintended consequences as banks are having to deal with new and highly complex regulations regarding lending, adding layers of administration and cost to their procedures.
Dr. Ertan explains: “The introduction of the new rules – just prior to the pandemic – has come at a particularly difficult time to test a new lending regime. Many more organisations than would normally be the case have been seeking financial support to sustain them during the current difficulties.
“In line with the new rules, banks have been obliged to take a stringent approach causing them to reduce their lending portfolios, often increasing interest rates and collateral demands. Similarly, loan size may be reduced or maturity dates shortened.
“In consequence, the SME sector is being forced to tighten its belt – exactly at a time when it is in greatest need of flexibility. Smaller businesses are most likely to suffer under the new regime as they typically have fewer sources of funding than larger organisations, rendering them heavily reliant on their bank.
“Given the economic importance of SMEs to the wider economy, this is extremely concerning. Taken across Europe and the US, SMEs represent over 99 percent of non-financial companies, employing more than two-thirds of the non-financial workforce and generating over half of total gross value added. So whatever affects SMEs has huge significance to us all.
“Despite the serious impact which the new accounting rules are undoubtedly having on swathes of the SME sector worldwide, it was entirely appropriate for regulators and policy-makers to review bank lending practices in the wake of the 2008 crisis. The aim of the regulators has rightly been to moderate lending practices in order to smooth the peaks and troughs of economic cycles and hence protect global economies for the benefit of us all.
“So while IFRS9 is a good idea, the benefits must be carefully weighed against costs. IFRS 9 introduced a shift to the so-called ‘expected loss’ system from the ‘incurred loss’ arrangement, obliging banks to decide whether to make a loan based on what is expected to happen rather than what has happened in the recent past. This changes the whole economic model of lending at a time when businesses have been at their most vulnerable.
“So what are some of the options? Banks could freeze dividends and share buybacks to keep equity high, but these may be unpopular with shareholders. Arguably, policy setters might consider temporary and partial relaxation of the rules and, of course, governments around the world have tried to help by providing some direct funding to organisations.
“A resilient banking sector is important as it can help to soften the blow caused by macro-economic upheaval. It’s therefore in all our interests to support policy makers in finding a smooth path for banks, companies and taxpayers.
“The intention of my recent study is to inform this debate by surfacing and interpreting large-scale, recent and relevant data.”
For further information, see Dr Ertan’s recent article in The Banker, 'Calculating expected lending losses and facing unexpected costs.'