Will SME Loans Be Blocked? Banks Say "Tens of Trillions in Additional Capital Needed Under Capital Floor Regulations"

Capital Floor Raised to 70% Next Year, Expanding to 72.5% by 2028

Greater Burden as 100% Risk Weight Applied to Loans for Unrated Companies

Banks Call for "Exception Rules for Unrated Companies"

Starting next year, as the final Basel III capital floor regulations are strengthened, concerns are mounting that banks’ capacity to lend to small and mid-sized enterprises (SMEs and mid-tier companies) could be constrained. There are also projections that the additional capital banks will need to accumulate due to the stricter capital requirements could reach tens of trillions of won. Banks have reportedly requested that financial authorities consider exceptions for unrated companies, arguing that the expansion of productive finance may conflict with prudential regulations.

According to the financial sector on June 1, under the final Basel III rules, the capital floor ratio will be gradually increased from 65% this year to 70% next year, and to 72.5% in 2028. The capital floor is a system that prevents banks from lowering their risk-weighted assets (RWA) below a certain percentage of the amount calculated by the standardized approach, even if they use the Internal Ratings-Based (IRB) approach, their own credit assessment model. In simple terms, this means banks are prevented from assessing asset risk levels too low. This rule was introduced to stop banks from excessively reducing risk weights for assets by using their own internal models.

Major domestic commercial banks currently use the IRB approach, which is approved by financial authorities, to assess credit risk for corporate loans and to calculate RWAs. However, under the capital floor regulations, RWAs calculated using the standardized approach must also be considered. The IRB method reflects factors such as the probability of default (PD) and the loss given default (LGD) for each borrower, which generally results in lower RWAs compared to the standardized approach.

However, as the capital floor ratio increases, the advantages of the IRB approach are diluted. This is because, even if the internal model assesses risks as low, the RWA must be set at or above a certain percentage of the standardized approach calculation. For example, even if the RWA calculated using the IRB approach is 5 billion won, if the standardized approach calculates it as 10 billion won and the capital floor ratio is 70%, the actual RWA applied will be 7 billion won. This means 2 billion won more in RWA is recognized compared to the internal model’s results.

The critical issue concerns loans to SMEs and mid-tier companies. Currently, only certain major corporate borrowers hold external credit ratings from domestic and global agencies such as Fitch and Moody’s, but the majority of SMEs and mid-tier firms are “unrated companies” without such ratings. Under Basel regulations, the standardized approach typically applies a 100% risk weight to unrated companies.

Given these circumstances, as the capital floor ratio increases, banks will be required to accumulate more capital for the same amount of lending. This is because as RWAs increase, the BIS capital adequacy ratio—a key indicator of soundness—decreases. As a result, banks face a heavier capital burden. An executive at one of the top five commercial banks stated, “The additional capital that the five largest banks would need to set aside could rise to the tens of trillions of won.”

There are also concerns that such regulations could weaken momentum for expanding productive finance. As capital regulations become stricter, banks are more likely to adjust their portfolios toward assets with relatively lower risk weights in order to reduce their burden.

Another executive at a commercial bank commented, “The tighter the capital regulations, the harder it becomes to increase lending to SMEs, regional companies, and partner firms. From the banks’ perspective, they have no choice but to prefer low-risk assets, which allow for more lending with the same amount of capital.”

With fears that the capital accumulation burden will rise as early as next year, banks have reportedly suggested to financial authorities that they either introduce special exceptions for unrated companies or temporarily relax or defer the application of the capital floor regulation. In fact, the ECB and the UK have adopted more flexible supervisory frameworks than the Basel regulations by recognizing banks’ internal assessments for unrated companies to a certain extent.

The Financial Supervisory Service is also reportedly considering whether to improve the system. However, it is maintaining a cautious stance, citing the need to ensure alignment with international standards.

Kim Yongjin, Professor of Business Administration at Sogang University, stated, “Strict capital floor regulations could become a factor that shrinks the supply of finance to SMEs and innovative companies. Rather than maintaining the current 65–72.5% range, it is necessary to consider certain supplementary measures to support productive finance.” However, he added that it is important to strike a balance between the two policy objectives of soundness and financial support.

This content was produced with the assistance of AI translation services.