Are Capital Requirements on Small Business Loans Flawed

Abstract We show that capital requirements on small business loans (SBL) based on Basel Committee’s Internal Ratings Based (IRB) rules are too high relative to those for corporate loans (CL), as they are not based on actual SBL data. We argue that SBL are not put on a level playing field with CL, whose requirements were calibrated on historical data. We show that such a discrepancy has real effects, as disproportionately high capital requirements are linked to lower credit availability for small businesses. In order to treat CL and SBL proportionately to their correlated credit risk, the IRB rules should require 45% lower capital requirements on the latter.