In this regard, the 1988 Basel Capital Accord was a milestone. For the first time, supervisors in the major banking markets agreed on a definition of capital and a minimum requirement. While we all recognise that these rules are not sophisticated, they are easy to apply, a fact proven by their ultimate adoption in over 100 countries. More importantly, they reversed a downward trend in internationally active banks’ capitalisation, thereby strengthening the soundness and stability of the international banking system and enhancing competitive equality among internationally active banks. However, in the years since 1988, the drawbacks of a simple approach to capital regulation have become more apparent. Advances in technology and telecommunications, innovation in banking products and services, and the increasing globalisation of financial markets have changed the way banks measure and manage risk. Today, the 1988 Accord no longer provides these banks - and their supervisors - with reliable measures of the actual risks they face. BIS Review 32/2003  1  In response, the Committee decided in the late 1990’s to refine the measures for assessing and managing risk. Rather than treating all loans to corporate borrowers the same way, for example, the New Accord will permit banks with less complex exposures to rely partly on external credit ratings when determining their capital requirements under the “standardised” approach to credit risk. In turn, more advanced banks will rely in part on their own internal assessments of a borrower’s credit risk under the “internal ratings-based” approach.

Even though probabilities of default may be higher for individual SMEs, our research identified persuasive empirical evidence that most banks’ holdings of loans to SMEs benefit from a greater degree of diversification than their holdings of loans to larger corporations do. Diversification helps to reduce both a bank’s exposure to the credit risk posed by SME lending and the commensurate need for capital. Moreover, we’ve taken a closer look at the precautions banks take when lending to smaller businesses, such as asking for guarantees or collateral. These measures help to lower further the potential losses a bank might incur in lending to a small business and can similarly reduce the need for capital. Our findings motivated revisions to the proposals that will prevent an across-the-board increase in capital requirements for SME lending. What’s more, our “quantitative impact studies” have generated solid proof showing that, on average, many banks’ requirements will actually decrease. Three changes to the New Accord are especially relevant. ·  First, in addition to an overall flattening of the risk-weight curve for corporate credits, we have reduced directly the capital charges for loans to smaller businesses. For example, banks on the IRB approach will be permitted to adjust downward the capital requirements on exposures to small businesses with up to € million in annual sales. This adjustment will reduce the capital charges on a loan to an SME by as much as 20% compared to the new requirements for larger companies and may in many cases be lower than the current requirements.