Sebok wg 2 final report

Third sector enterprises banks as a reference are:

	Any Bank	One bank as a reference	Specialized bank	Co-operative credit bank	Traditional bank	Other qualified financial broker
	%	%	%	%	%	%
Legal Form
Not admitted Committees and Associations	17,9	82,1	17,4	0,0	82,6	0,0
Legally admitted association	7,7	92,3	8,3	16,7	75,0	0,0
Foundation	0,0	100,0	0,0	0,0	100,0	0,0
Social co-operative	32,8	67,2	9,3	14,0	69,8	7,0
Other	25,0	75	33,3	33,3	33,3	0,0
Sector
Culture, Sport and recreation	24,0	76,0	21,1	5,3	73,7	0,0
Education and research	14,3	85,7	8,3	0,0	91,7	0,0
Health board	33,3	66,7	25,0	25,0	50,0	0,0
Social care	22,9	77,1	5,4	16,2	75,7	2,7
Other activities	22,9	77,1	11,1	11,1	70,4	7,4
Size ( with reference to the number of employees)
From 10 to 20 employees	24,7	75,3	14,8	9,8	70,5	4,9
Over 20 employees	19,1	80,9	5,3	13,2	81,6	0,0
TOTALE	22,7	77,3	11,1	11,1	74,7	3,0

Source: Survey CRC 2003

IV.REGULATORY FRAMEWORK

1. Risk management, Basel II

BASEL II AGREEMENT

1. 
   Introduction to Basel II
   

The underneath meaning of Basel II it’s second agreement about the international convergence of capital and patrimonial coefficient measurement.

New scheme regulation, drawn up in 2004 from the Basel committee for the banking surveillance. This committee has been operative since 1974 as a inner organ of BIS Bank of International Settlement and is led by governors of the central bank of the 10 most industrialized countries (Belgium, Canada, France, Germany, Italy, Japan, Luxemburg, Holland, Sweden, Switzerland, United Kingdom, United States). BIS is one of the most important and ancient international banking organizations, created to improve the cooperation between central banks and other financial operators and also to maintain monetary steadiness.

The second Basel agreement, which will be effective from January first 2007, followed the first one which is about measurement and management of credit’s risk as well as patrimonial requirement that banks and investment enterprises, operating on a international level must own to properly face the global economy potential risks.

Basel 2 aim to maintain the patrimonial stability of Credit institutions, purposes pursuit not only for macroeconomics international targets but also to defend people who put their savings in these banks.

Changing introduced by Basel 2 went after the evolution of the banking system which goes toward a risk management more quantitative and differentiated. The new discipline provides to the banks all the necessary instruments to a detailed evaluation of the risks connected to any allocated loan. This is possible trough a deeper analyses of the client’s capacity to pay back the money that he has borrowed.

2. 
   The evolution of the agreement for the international banking surveillance: from Basel 1 to Basel 2.
   

The main target of Basel 1, reached in 1988, was to set up homogenous and international rules in order to avoid that unscrupulous politics of some bank would have led them to fail with a domino effect for other banks, which would have brought finance unstableness for the entire economic global system.

Based on this targets were introduced principles in order to guarantee appropriateness patrimonial of the banks such as:

• 
  Any bank’s institute activity imply a certain risk level
  
• 
  This risk must be identified and quantified and must be covered by a “ surveillance capital” kept by the bank.
  

Basel 1 has introduced, then, a patrimonial minimum requirement which consist of the availability of a minimum capital in order to protect third creditor parts from the coming true of risky events connected to responsibilities hired by the banks.

The patrimonial appropriateness was established trough a minimum relation of the 8% between:

• 
  Surveillance patrimony
  
• 
  Activities evaluated on the credit risk ( meaning the possibility to suffer losses because of debtor insolvency) and the market risk ( meaning the implied risk
  

in purchasing finance instruments on the market) which are respectively equal to 92.3% and 7.7% of the total risk.

Basel 1 effectively increased the capitalization level of the banking system which means a higher protection from the credit risk. This led to a better efficiency of the international banking system which gained solidity and stability.

Nonetheless this agreement had limitation which consist of:

• 
  Static measures of risk and not much differentiated: credit risk was determined only in a generic way, considering only the typology of the counterpart instead of the specific client.
  
• 
  Diversification of the portfolio wasn’t considered as a factor of credit reduction
  
• 
  Length of the finance wasn’t considered, as well, able to generate different entities of risk
  
• 
  The only typologies of credit risk were those prior mentioned.
  

3. 
   The main aspects of Basel 2
   

After 1988, the banking market evolution has been kept under strict control from the Basel committee, Authority of national Surveillance and banks in order to improve the discipline introduced with Basel 1. Based on this control activities new purposes have been set in Basel 2:

• 
  Strengthen the solidity and stability of the finance system
  
• 
  To facilitate competitive parity among banks
  
• 
  Strengthen the relation between patrimonial consistency and risks related to banking operation
  
• 
  Different risk for different counterpart
  
• 
  Set up more accurate procedure of risk measurement
  

Even the second agreement of Basel, defined in 2004, has among its purposes to strengthen the stability of the financial system, what change it’s instead the method followed by this second agreement, which is to integrate the public’s regulation expectation with an accentuation of the market characteristics. In this way has been introduced by the new agreement the evolution of the bank surveillance model, which went from administrative modalities with an authority’s direct control to an indirect control based on the market discipline. This new approach allows banks to make choices based on business and management considerations rather than normative obligations. Basel 2 is composed of three main parts properly called “Pillars”, that together concur to realize the same purpose even though the first one is the most relevant

First Pillar: minimum patrimonial requirement

This pillar is about the patrimonial solidity of a bank and provides new rules of risk quantification. The main elements of Basel 1 are maintained, so for the 8% minimum leverage coefficient, but then some important changes are made:

1. change of the credit risk definition, that add to the prior definition as it was (the counterpart insolvency risk) :

• 
  retrieval risk, meaning the loan percentage that the bank would lose in case of insolvency
  
• 
  exposure risk, meaning the money that the bank would lose in the same case
  
• 
  deterioration of the credit’s merit, which depend on the remaining length of the loan and express the economic residual expiration of the exposition
  

2.Introduction of the operative risk, meaning risk if losses would come from human mistakes, technical or procedural problem inside the system or from outside events.

3.Introduction of new procedure to calculate credit risk, based on the concept of “rating” that reflects the evaluation of solvability of a debtor. The rating allows different evaluation of the same type of exposition trough the possibility to assign different merit level to single clients. There are different rating procedure:

• 
  New standard method, it’s based on extern rating, with evaluation made by specialized institution like Standard & Poor’s or Moody’s, that guarantee independence, transparency and judgment objectivity. Furthermore it provides a modify of the consideration coefficient, going from one to five classes (from 20 to 150%), that allow a different clients risk evaluation and subsequently to tie the credit price to the different class of risk
  
• 
  IRB International Rating Based made from the bank trough a straight client’s evaluation. The usage of this procedure is probably the main innovation brought by Basel 2 and it has created an argument among the experts. The adoption of this internal rating presume an authorization granted to the bank from the surveillance authority. The IRB can be “basic” or “advanced”
  
• 
  in the basic one, the bank utilize a self-developed procedure to valuate the probability insolvency which means to rate the client, but uses parameters defined by the Surveillance Authority to determine the retrieval risk, exposition risk and deterioration of the credit merit
  
• 
  in the advanced one, the bank make an evaluation of the all four requirements using procedure and model developed on its own inside.
  

Basel 2 also states that all the construction modalities of inner rating must be documented and kept in a transparent way and that they are subject to periodic revision. Under the Bank profile the inside rating procedure produce an improvement of the management risk procedure and the liberalization of capitals that are, once again, available for new utilizations.

This procedure require a mentionable employment of resources.

Second Pillar – Prudential control of the Surveillance Authority

In Basel 2 the Surveillance Authority has a particular importance ‘cause it has the duty to supervise and guarantee that all the bank will activate appropriate inside process to evaluate their patrimonial appropriateness, evaluation based on a real measurement of the exposure’s risk. Following this prospective the second pillar was set up to make effective the cooperation between banks and national Surveillance Authority in order to be able to take as fast as possible all the necessary measures in case of issues about patrimonial appropriateness.

Third Pillar – Market discipline and bank’s informative

It defines modalities and contents of the communications, from the bank to the market, about the risk hired by the bank and the methods followed to measure, valuate and manage.

The third pillar basically stimulate the market discipline – law obligations and market expectations – through a informative regulations about purposes and strategies that the banks communicate to third parts in order to pursuit market steadiness.

This communications generate market expectations that must be satisfied by the bank, trough a sort of auto regulation directory of their own behaves.

The new procedure put on by Basel 2 is based on the significance principle, meaning that an information has to be considered significant if its omission or wrong indication it potentially able to influence or modify decisions or judgment of the market actors. This procedure is about different information aspects:

• 
  fundamental informative: which is about information with a central importance for the bank and a correct execution of the market discipline.
  
• 
  supplementary informative: about further areas of the bank activities compared to those mentioned on the previous item
  

The informative, up to Basel 2, must be made public every six month and the information must be verified at least every year.

In case of information violation the Surveillance Authority can adopt corrective measures of the situation.

4. Agreement of Basel 2 inside the legislative frame of the European Union

Basel 2 has been tuned up by a committee without legislative power which means that its statement are not endowed with legal force.

Its guideline, standard and recommendations though, have been formulated in such a way that put the national or international (for ex. UE) Authority in condition to adopt the operative regulations as proposed in the intern accord of the respective legislations.

Because the SME small and medium-sized enterprises depend on the credit concession, the UE has kept monitored all the changing happening inside the banking market, included the bank patrimonial requirement reform introduced by Basel 2.

Since the beginning the European Commission has followed this reform process and it has proposed a directive to adopt the new international banking regulation inside the Union, paying attention to the specificity of any partner country.

This directive was approved in September 2005 through a resolution of the European Parliament which got accepted in October 2005 from the European Council of the Finance Minister, so becoming part of the European legislation.

5.The impact of Basel 2 on the enterprises

Basel 2 will require to the banks a more accurate calculus of the riskiness connected to the credit allocations with a subsequent major diversification in order to group clients in different classes of risk.

This innovation made up new concerns in the enterprise’s world, especially Italians, correlated to a likely aggravation of the credit’s access conditions. The new regulation in one hand will make easier for the client classified less risky to accede at the credit and in the other hand more difficult for the client classified riskier, because banks will apply higher rates to this last category.

This new situation seem to work against SME ‘cause they have a higher risk of insolvency compared to that belonging to big enterprises. It’s important to underline that Basel 2 – especially rating model – was based on the Anglo-Saxon financing market functioning, where the enterprise’s size is usually bigger than in Italy.

In Italy some study were done on the plausible impacts of this new normative:

A study conducted by Union of Italian chambers 2003 to estimate the probability of insolvency of stock and limited companies after Basel 2, showed that among these society the 17.5% were unable to receive a credit, 65% had conditions that were bringing to a higher contractual costs, while only the 17.5% were able to benefit the improvement in the credit conditions.

A Prometeia’s study on the SME with less of 50milion Euro of invoiced showed that about the 20% of this enterprise was characterized by low credit’s quality and difficulties to access at the credit on the conditions provided by Basel 2

A study info chamber ( source: Sergio Nanni, “Guida operative alla nuova normativa finanziaria”) showed that about a third of the enterprises would have suffered an increase in the credit’s price during Basel 2 regime effectiveness.

A study conducted by Union of Italian chambers (2005) on personal enterprise and sole-proprietor firm, belonging to a variety of economic areas( manufacturing, construction, commerce, hotel and restaurant, transport, monetary intermediation, real estate, research and computers system) had some positive results showing that 96% of this enterprises is not in a situation of insolvency risk. We should also underline that on march 30 2005 the active enterprises were:

• 
  67% sole-proprietors firm
  
• 
  18% personal company
  
• 
  13% stock company
  
• 
  2% of other juridical forms
  

The enterprise’s concerns can be mitigate by some considerations though:

First of all Basel 2 provides a diversification among different entrepreneurial realities:

b) SME retail, with an invoiced inferior to 5 millions

c) SME corporate, with an invoiced in between 5 & 50 millions

d) enterprises corporate, With an invoiced major than 50 millions

About credit access conditions, Basel 2 provides increasing facilitations in inverse proportion of the enterprise’s size. This facilitation went after the European Union indications which established a predominance, in number and economic importance,

of the SME.

Second of all, it’s important to underline that the bank which activities is oriented toward SME can reduce the riskiness of their obligations through a client portfolio diversification, which spread the risk on a higher number of enterprises.

Consequence of what above it’s that the banking world won’t be forced from Basel 2 to diminish the credit obligations toward these types of enterprises , also because rating itself doesn’t bring to an enhancement or reduction of the money’s cost, but only to a duty’s bank to collect and valuate the information about potential clients in a more detailed way compared to the past.

2.Information obligations

The new scenario coming from Basel 2 will bring important consequences on the SME world, whether in the relationship with credit institute or in their inside.

First of all it’s necessary to underline that the rating procedure will require new modality of communication between banks and credit institute. So banks have to communicate to their clients the class where they fit into and then motivate this choice other than express clearly the factor’s risk that the bank has considered more relevant. This informative duty on the rating procedure modality from the banks to the client even though not provided by the agreement was ratified by the European Parliament during 2005. A bank refusal to give this kind of information, beside normative obligations, would be a criteria not to choose that credit institute.

Enterprises, on their side, are evaluated mainly on three kind of information:

• 
  quantitative; finance-economic information findable in the revenue account or in other financing document
  
• 
  qualitative; about process of management control, budgeting, organization structure, type of governance ( unique administrator, family run, administration council etc.), results obtained by the enterprise compared to what planned and the sector’s trend
  
• 
  trend; about the prior relation between the client and the banks, deducible from two sources: Central of risk (managed by the Bank of Italy) and the previous relation with the referring bank.
  

Based on what said above this new situation will take an improvement of the competitiveness through strategic planning, budgeting process, management control.

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