Are Capital Requirements on Small Business Loans Flawed?

We explore an inconsistency in the Basel Committee’s Internal Ratings Based (IRB) rules: the capital charges on corporate loans were calibrated to loan-level data, while the capital charges on small business loans were calibrated to fit the capital that a few international banks held prior to this regulation.We argue that the IRB capital charges do not put small business and corporate loans on a level playing field. While downturn risk of corporate loans is accurately captured by the IRB formulas, we show that small businesses have low downturn risk and require 3.5 times lower capital charges than those prescribed by the Basel Committee.