Small businesses may have difficulty getting loans in the future as Canadian banks begin to phase in the new Basel Capital Accord, Basel II, during the next three years says Dragica Grbavac, President of Tri-Media Corp.

Basel II is a set of regulations that financial institutions around the world must comply with to reduce credit, market, and operational risks. If passed, the new Accord will force banks and insurance companies to establish capital reserves that can cover these risks. For small businesses this may mean that banks will become more risk adverse than they currently are.

"How banks worldwide implement the new rules will impact businesses' access to new loans," says Grbavac, who is an expert on Basel II and its impact on financial institutions.

Businesses that once qualified for loans with ease may be denied money in the future as banks start to follow the new "sound practices", says Grbavac. Some of the possible fallouts for small business include:

• Banks will have less money available for loans, as money is tied up in reserves.
• Banks will likely screen loan applications more carefully, and can be expected to favour low-risk borrowers.
• The more comprehensive lending process may result in extra red tape during the application process.
• Strict loan qualification requirements will eliminate many small business opportunities.
• Borrowers will be subject to demanding business reporting; and
• The viability of a business venture and its risk level will be continually questioned.

When it comes to assessing credit risk, banks will have to use a 'risk rating' system to assess risk throughout the organization. The risk rating system will affect businesses that want to access government guaranteed loans. Because government guaranteed loans are not guaranteed 100 percent, under Basel II, the non-guaranteed portion of any such loan will become a direct risk to the bank. Banks will likely demand higher levels of collateral, which will place risk squarely on the shoulders of business people.

Impact of Basel II's requirement will be felt by banks

Some Canadian banks are scrambling to meet a year-end deadline to create a sophisticated approach to measuring risk. Others will opt for a basic approach but will have to set aside larger capital reserves.

"While most financial institutions worldwide support Basel II, some American institutions are balking at the intended broad strokes of the Accord. Although Basel II will go through regardless of what the US financial institutions do, its absenteeism will make the US a vulnerable spot for investors - not an enviable position," says Grbavac.

Banks world-wide have until July 31, 2003 to comment on the proposals of Basel II. American Congress has met three times to debate whether US financial institutions should comply with the Accord. The implications of time, money and resources are more serious in the US than in Canada.

"The US has a fragmented financial services industry, with a potential to compromise the stability of financial services worldwide, Grbavac says. "By comparison, in Europe, the Governments of the European Union have already drafted preliminary laws that will reflect the sound practices of the proposed Basel II Accord."

All Canadian financial institutions will be subject to the regulations, which will take effect by 2007.

Dragica Grbavac is an internationally recognized authority on optimizing administrative and operations processes of financial institutions. She can be reached at Dragica@TriMediaServices.com and http://www.TriMediaServices.com.

If you enjoyed this article, be sure to visit CanadaOne's article knowledge base for more informative articles.