Small firms safe, says architect of Basel II banking regulations

Date: 10/10/02

By Peter Chapman

SMALL companies and their bankers will not be squeezed out by controversial new rules forcing lenders to set aside enough reserves for bad loans, the architect of the reforms insisted this week.

William McDonough, chairman of the Basel Committee - the group of bankers working on the new accord known as 'Basel II' - said it would be adapted to ensure small firms do not face a financial drought when the rules come into force.

McDonough - also president of New York's Federal Reserve Bank - said that means the sector will remain the engine room of the global economy.

'I am a student of the Joseph Schumpeter school,' added McDonough, referring to the economist who coined the phrase 'small is beautiful' in his book expounding the virtues of small business.

'The way it works is there must be a source of credit available to entrepreneurs. Otherwise economic growth does not take place.'

The new rules, set to be finalised in April 2003, will adapt the existing banking regime to take account of the more sophisticated ways banks have to measure the risks they face when they lend money.

However, critics said early drafts of Basel II, which will eventually be incorporated into EU law, could have condemned small firms to sky-high rates of interest for their bank loans.

The firms could also have struggled to find a loan because banks would have been forced to set aside relatively large amounts of capital to cover the extra risk of lending to them.

The impact of the new rules on small firms - known as Mittelstand in Germany - was one of the surprise battlegrounds of the German general election.

But McDonough said he had tried to deflect criticism of Basel II, explaining to re-elected chancellor Gerhard Schröder and his challenger Edmund Stoiber that this pillar of the German economy was safe.

'When I met Stoiber and Schröder I told them that I believed in the mittelstand even more than they did.

'One would think that the US is a country of large business but actually all creation of jobs is from the Mittelstand.

'When we [the US] were creating three million jobs a year there was a net job destruction [in big companies].

'The Mittelstand was creating three million new jobs plus making up for the destruction.'

Small companies and their bankers will not be squeezed out by controversial new rules forcing lenders to set aside enough reserves for bad loans, according to William McDonough, chairman of the Basel Committee.