Regulatory Alerts2015-10-26
Categorization of Loans to Small and Medium-Sized Enterprises as Mass Market
The Norwegian Financial Supervisory Authority issued Circular 11/2015 to clarify the requirements for categorizing loans to small and medium-sized enterprises (SMEs) as mass market, emphasizing that such classification reduces capital requirements for credit risk. The circular mandates that institutions must establish board-approved guidelines ensuring portfolio diversification and risk reduction, with a specific note that the standard 1 million euro limit may be too high for the Norwegian context. Furthermore, Internal Ratings-Based (IRB) banks are required to obtain prior approval for their categorization guidelines from the regulator, which applies stricter documentation standards to limited liability companies compared to sole proprietorships.
Circular Categorization of loans to small and medium-sized enterprises as mass market CIRCULAR: 11/2015 DATE: 26.10.2015 THE CIRCULAR APPLIES TO: Banks Holding companies Financing companies FINANS TILSYNET Postboks 1187 Sentrum 0107 Oslo
Categorization of loans to small and medium-sized enterprises as mass market 2 | Finanstilsynet Introduction This circular explains the Financial Supervisory Authority's general assessments of the categorization of small and medium-sized enterprises (SMEs) as mass market, and clarifies that changes to the categorization procedures for IRB banks require approval from the Financial Supervisory Authority. Background – rules on capital requirements The Capital Requirements Regulation, which implements the EU capital adequacy framework, allows for the categorization of loans to small and medium-sized enterprises (SMEs) as mass market. Mass market categorization entails reduced capital requirements for credit risk as a result of lower risk weights under the standard approach and a reduced correlation parameter in the risk weight formula under the IRB approach. To qualify for lower capital requirements, the mass market portfolio must consist of many exposures with similar characteristics and be well-diversified so that the risk in the portfolio is significantly reduced (cf. Capital Requirements Regulation §§ 5-8 and 9-1). Furthermore, each individual exposure must be under 1 million euros, and for the standard approach, there is also a requirement that individual exposures cannot constitute more than 2‰ of the entire portfolio.1 Details on mass market categorization Institutions that categorize SMEs as mass market must have board-approved guidelines that delimit the portfolio and ensure that the requirements for mass treatment, diversification, and risk reduction are met. The Financial Supervisory Authority has previously communicated that the amount limit of 1 million euros is high for Norwegian conditions and expects institutions to set their own amount limit that is reasonable based on the institution's portfolio and risk profile. Institutions must also regularly monitor that the mass market portfolio meets requirements and guidelines, for example as part of IRB banks' validation. IRB banks must have their guidelines for categorization approved as part of the application process, and they must then document that the requirements for mass market categorization are met. Changes to the categorization require permission from the Financial Supervisory Authority according to the technical standard for model changes (Commission Delegated Regulation (EU) No 529/2014 of 12 March 2014, cf. Finanstilsynet's circular 3/2015). The Financial Supervisory Authority considers it particularly demanding to document reduced risk for limited liability companies, as this type of company generally has relatively high risk. The Financial Supervisory Authority therefore sets stricter requirements for documentation and guidelines to categorize such companies as mass market than to categorize sole proprietorships in this category. 1 The quantitative limits do not apply to exposures with security in real estate, which are excluded from the calculation of total exposure.
Categorization of loans to small and medium-sized enterprises as mass market Finanstilsynet | 3 Banks using the standard approach should be particularly careful when including limited liability companies in the mass market portfolio, as there is no documented lower risk for such exposures. The Financial Supervisory Authority also refers to the fact that the Basel Committee in its consultation paper on the revised standard approach has proposed additional requirements for mass market exposures to obtain reduced risk weights, such as requirements for collateral security and repayment ability. Emil Steffensen director for banking and insurance supervision Bjørn Andersen section head Contact persons: Special Adviser Inga Baadshaug Eide, tel. 22 93 99 47, email: inga.baadshaug.eide@finanstilsynet.no Senior Adviser Ingrid Hyggen, tel. 22 93 99 07, email: ingrid.hyggen@finanstilsynet.no
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