Basel in faulty SME paperwork danger
A new worldwide banking agreement means that SMEs will suffer if they are not in control of their documentation.
A new banking agreement on capital adequacy, known as Basel II, is about to change the attitude of banks towards borrowers, especially small and medium-sized enterprises (SMEs).
Drawn up by the Basel Committee and formed by central banks, the new Basel Capital Accord is an update of the 1988 agreement that was adopted by more than 100 countries, including the UK. Basel II is set to be applied worldwide.
High street banks are reviewing their portfolios using the criteria laid down by Basel II, although the accord will not come into effect before 2005.
The criteria will be in the form of a bank internal rating, designed to allow a more accurate assessment of the true risk of a loan. The rating will take into consideration hard facts, such as company accounts.
However, the number of facts SMEs will have to file with Companies House is being reduced. As a result, banks will be looking more closely at the soft facts of a business, such as the competency of an SME's management and its market position.
This raises the question of whether borrowers will be able to present the relevant facts about market position, strategy and their own financial controls.
SMEs, including value-added resellers, tend to have a low capital base and depend heavily on bank financing. If they do not prepare the right documentation they may end up with a poor rating from their bankers. This will be compounded because banks will have to apply standard criteria across the board.
Therefore, if an SME is turned down for finance by one bank it is unlikely to get it from another and will be forced to look for alternatives. If this hasn't been considered earlier it may cause the company to fail.
The world of credit ratings and risk scoring has changed in recent years. Larger organisations, whether trade distributors, credit insurers or banks, have taken advantage of sophisticated scoring tools. All scoring and rating mechanisms depend on being fed with relevant risk data.
Commercial credit reference agencies such as Graydon, Experian and D&B have tried to satisfy demand from their clients by producing credit data and scores on which decisions are made. If the data is not available on a particular risk, a negative rating will probably be produced.
My advice to SMEs is to keep their documentation up to date, as this will increasingly be needed if they are to find the levels of finance they need to survive.
Alan Norton is head of intelligence at Graydon Credit Management.