Capital Ratios: Regulatory
March 4, 2010, 5:00 am
Copyright © 2010 Integrated Profitability TM
For some companies, there are special ratios related to capital. Government regulators specify certain minimum levels of capital for corporations in particular industries. The regulators are also very specific as to what may be included when calculating these ratios. The most visible industry is financial institutions where regulators require a certain amount of capital be maintained at all times to protect customers (e.g., consumers depositing their savings in a bank).
The intent is to ensure that there is always a certain level of capital to protect against financial difficulties. These ratios are a kind of forced financial prudence. The main one for financial institutions is the “Capital Adequacy Ratio” (CAR). It’s calculated generically as follows:
Certain types of Capital / Risk-weighted Assets
Both the numerator and the denominator use specific categories of capital and assets respectively because neither is created equal. Assets can become impaired in completely different ways, under different circumstances, and with completely different speeds. Therefore, assets are weighted by the amount of risk they bear. These assessments quickly become complicated. Suffice to say, the capital ratios are specified with the intent of maximizing the ability of the bank to stay in business.
Here are a few pertinent websites:
● Bank for International Settlements and the Basle Committee
● Article on Capital Ratios from the Motley Fool
● Capital Ratio from Answers.com
At the end of the day, regulatory ratios are just another requirement of doing business. If you are in a regulated industry with mandated capital ratios, this is one more environmental aspect you must meet. It is the same as any business that sells a product or service subject to sales (and other) taxes: you must be aware of them and you must abide by them.
If you don’t, your resources will be commandeered to deal with the non-compliance. Your time and effort will be directed toward responding to regulators, defending your position (if you have one), and rectifying the issue to the satisfaction of the regulators.
Bottomline: You may think capital ratio requirements are onerous, but they have been put into law for solid economic reasons. The driving force may not be to specifically protect you (the owner), but if the margins give you a bigger financial cushion, thereby making your business safer, then they do, in fact, help you.
If you are in a business that requires regulatory margins, know what they are and make sure your business model and profit dynamics include them.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 56
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
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