The 2008 financial crash has understandably made the banks warier of having riskier assets with a high-risk weighting on the balance sheet. James & David discuss what this means for corporates, and how they can reduce the danger of incurring higher costs of financing.
What are the implications of the Capital Adequacy Ratio (CAR) on organisations looking to raise funds?
The CAR is inevitably going to have an effect on all types of organisations because ultimately the banks are going to be looking at that ratio and saying ‘well the capital to risk-weighted assets, we need to make sure that we’re above the specifies tolerance’ – the higher you get that ratio the better it looks from an external perspective.
So, as capital adequacy ratios reduce the appetite of the bank to have those riskier assets with a higher risk weighting on the balance sheet, then inevitably they’re going to start removing some of those and that will then lead to higher cost of financing for organisations.
The CAR has even become more of an issue for fund managers as well so in operating the number of funds that they do, it is quite vital that they keep sufficient capital to cover any losses within the fund. So, it’s an industry-wide thing and if you’re a bank as well with investments you have to have restitution risk capital set aside as well. It goes back to Basel III. So, if you look at a bank today, they’ll have very little appetite to have non-operating capital within their books because of what’s happened previously with the financial crisis. So, for non-operating capital, they’re trying to reduce that as much as possible, but they are, from a risk restitution perspective they do have to keep a certain amount available. However, it is an exposure, so monitoring these types of balances and liquidity elements are very key for any institution.