As of 2008 the new Basel accord ('Basel II') has been applied to domestic banks. There were many issues because the methodology of measurement in credit risk and scope of assets included operational risk, undrawn lines and credit derivatives were complicated. This study shows and focuses on the impact in small medium enterprise's loan portfolio and the strategy of local bank applying to the new basel accord. There are pros and cons about Basel II. Some people expects positive effect, especially it contributes development in risk management and sound financial stability in financial institutions. But others warned that banks should spend more costs to build and design IT infrastructure for Basel II and more strengthen risk rating system in banks would impose a severely financial burden of small midium enterprise('SME'). SME depends on bank's loan over 80% of their financial funding structure in 2007. Recently domestic banks have concentrated to increase loan of SME because financial supervisory service ('FSS') forced to reduce private and mortgage loans. The position of loan for SME comes to about 70% of their loan portfolio in Korea. The continuance of financial support for local SME is dependent on local bank's policy of loan. The change of regulatory capital could be influenced applying to new enforcement regulation and banks keep over 8% of bank' capital ratio. The role of local financial institutions are important to sustain stable settlement system for local economy and resource of SME's financial funding. Moreover loan portfolio of SME is mainly charged of local banks' loan portfolio.
This study is about impact study in loan portfolio of SME through the case of local bank. The analysis of a transverse section focused on comparison between Basel I and Basel II in credit risk as standardized approach and the observation periods were Mar 2007 and Mar 2008 for analysis of time series.
The result of this study showed the increase of regulatory capital in loan portfolio of SME applying to Basel II. There were two main reason. Frist reason is that recognition of undrawn lines and specialized lendings as risk weighted assets in credit risk. Second one is operational risk. But the result was different in detail as corporate size and categories of assets. The corporate recognised as a retail observed decrease of regulatory capital because the rule in Basel II applied to 75% for counter party's risk weights contrast to 100% of Basel I. And decrease of regulatory capital in the assets on balance sheets caused to credit risk mitigation such as letter of grantee, risk weights in residential real estate collateral. Local banks do not avoid increase of regulatory capital applying to standardized approach. But they should find the way to minimize negative effect to local economy and SME. And they keep protection for depositors and their financial stability.
As the result of analysis in this study, local banks should establish their own strategy for Basel II. Firstly, they should try to expend Tier I and Tier II capital to absorb increase of risk weighted assets. Secondly, Banks could do operate their own business within target BIS capital ratio and limit of risk weight assets. this method set up hard limit to obey before starting their business. It could set up for two dimension such as for counter party and each assets.
Thirdly, local banks give an advantage for retail banking in their internal performance management policy. It will be effective to encourage retail banking as RAROC (risk adjusted return on capital) and FTP(fund transfer price) policy that gives more margin as reducing regulatory capital cost.
Fourthly, local banks need long term strategies and plans to conduct for improvement of risk management system. This improvement does not mean only elaborateness to measure credit risk and operational risk. It contains the enterprise risk management, risk adjusted performance, equilibrium between return and risk.
Fifthly, local banks need the specific or specialized growth strategy. It should focus on network business with local SME and customer's satisfaction. So they need change the present channel, financial product and services and it concentrates to increase their customer's value.
Sixthly, the industrial cooperation is needed between local banks and SME for change of financial system. The communication programs are needed to understand change of financial institution's policy for SME.