Removal of the SME support factor

The PRA has confirmed the removal of the CRR SME Supporting factor under the Standardised and IRB approaches their near final rules for Credit Risk. However, an ‘SME Lending Adjustment’ will be introduced to offset the impact on the cost of SME lending. This is with the intention of ensuring that the cost of capital for SME exposures will be net neutral under the Basel 3.1 regime.

With this scheme, lenders can apply a discount of 15% or 24% to qualifying exposures of corporate and retail SMEs. Risk weights for unrated corporates that qualify as SMEs can currently be discounted from 100% to either 85% or 76%. For retail exposures, risk weights can be discounted from 75% to 64% or 57%. The split in RWA under the SME support factor is defined by the size of the exposure, with SME exposures under €2.5mn receiving the lower RWA treatment.

With the implementation of Basel 3.1, the PRA will apply a new risk weight treatment for unrated corporate SMEs, lowering the risk weight to 85% (previously 100%). Similarly, for retail SMEs, the transactor exposures approach will cause risk weights to range between 45% and 112.5%. Thus, the PRA argue that retaining the SME support factor would result in a ‘doubling up’ effect and imprudently low-risk weights for some SME exposures. This contrasts with the ECB which leaves the underlying SME risk weights unchanged (100% for Corporate SMEs and 75% for retail SMEs) but keeps the SME supporting factor.

The industry’s feedback on this proposal was that it would threaten the availability of financing for SMEs and significantly increase capital requirements for firms operating in SME market. In PS9/24, the PRA continues to argue that lower underlying risk weights for Corporate SME lending and introduction of the Pillar 2A ‘SME lending adjustment’ means removal of the SME support factor will not increase capital requirements for SME lending.