The Challenge of Raising Capital

February 18, 2003 by admin

Today, bank policies for lending are more refined and restrictive that they used to be. That’s the finding of a survey of more than 6,000 German companies conducted by a German credit institute. Some 32% of the respondents complained of increased difficulty in obtaining credit from banks; only 3% of companies reported that it had become easier to receive credit. The banks justify refusing credit mainly with their business policy, a lack of collateral, and the insufficient equity base held by companies.

Basel II

Basel II

Many other industrial nations exhibit less of a trend toward tightening credit. For this reason, discussions of the new Basel regulations (Basel II) in Germany are particularly controversial. Plans foresee the application of Basel II to credit institutes as of 2007. Nonetheless, large international banks have already begun to collect data on defaults so that they can access the data history when they need it.
The fundamental idea of Basel II is the differentiation of good and poor creditworthiness. Accordingly, the creditworthiness of a creditor is assigned a rating that expresses the economic ability of a company to meet its future payment obligations on time and in full. In the future, companies with insufficient capital will need to compensate for their risk of default with higher interest rates.
Credit institutes can use an external or bank-internal rating of a company for capital adequacy. However, because of costs, only a few firms apply for an external rating from a rating agency recognized by banking regulators.

Intensifying Dialog with Banks

Companies need to prepare themselves for the rating process early and comprehensively. Preparations include familiarizing themselves with quantitative and qualitative factors such as key indicators on the balance sheet or evaluations of products and management. However, experience shows that banks make no or only very general statements about how they weigh these factors. Nonetheless, an intensive dialog with credit institutes is advisable to understand better how they evaluate ratings. Such discussions more readily enable a company to undertake measures to improve its future rating.
The rating procedure at individual credit institutes can differ significantly, for example in the assignment to individual customer groups (company customer, commercial customer, or business customer). Accordingly, it’s worth comparing the internal ratings conclusions made by the controlling credit institutes. In some cases, it’s advisable to intensify business relationships with credit institutes that do not use an internal rating procedure. In particular, these are small institutes that select a standard approach. When issuing credit in the future, they can use the same risk weighting as today and not perform a rating.
The Basel regulations also provide that credit institutes can significantly expand the security instruments they can apply to a reduction of capital adequacy. Accordingly, the institutes will examine and possibly re-evaluate a company’s securities. In addition, banks can reduce capital adequacy by contractually reassigning the securities to the credit or equalizing the maturity and currencies of securities and credits.

Looking for Alternative Financial Avenues

Basel II strengthens the tendency evident today of banks concentrating on creditors with good creditworthiness and sufficient securities. The most recent regulatory relief is designed to counter this tendency. Accordingly, in Germany, it’s expected that credits of up to 1 million Euro for companies with annual revenues of up to 50 million Euro can be treated as credit to private customers. In addition, firms with less than 500 million in annual revenue will no longer need to pay maturity surcharges for long-term credit. Once Basel II has taken effect in national law, regulatory agencies can fix these limits in a given context.

Recommendations for Action

Recommendations for Action

Given the tight availability of credit, small and mid-size companies are increasingly considering alternative types of financing. These methods include public founding and support funds, but these are only partially utilized by companies. Other possibilities for attracting capital include a public stock offering. In addition, banks, savings institutions, and private investors make venture capital and high-risk capital available for innovative companies involved in growing markets.

Leasing as an Opportunity

Leasing is an additional alternative, even though leasing companies need refinancing from credit institutes and thus also must consider risks in leasing contracts. However, in doing so, the Basel guidelines don’t apply to them. That’s why it’s especially worthwhile for small and mid-size companies to investigate whether leasing assets might prove better than external financing in the future. In the context of Basel II, leasing investment assets brings companies an additional advantage. It increases the equity capital of the lessee, a circumstance that has positive affects on the risk evaluation by a credit institute. And that in turn simplifies access to traditional forms of credit. Additional options for raising capital include factoring or common securitization of credit for mid-size companies.

Customizing IT Systems

Basel II also challenges banks significantly. Many of the challenges affect the IT systems that have to map the new requirements. The required data is often unavailable in sufficient quality, or is distributed across various systems. Credit institutes are therefore faced with the task of customizing and expanding their IT landscape and data for Basel II. The requirements of Basel therefore lead credit institutes to move toward more uniform methods and procedures for measuring risk. And these measures then foster the development and adoption of the corresponding standard software. Special components tailored to the requirements of Basel II, such as the Bank Analyzer and Financial Database from SAP, support banks in their efforts to implement the Basel regulations.
In this context, credit institutes will make higher demands of company data to improve their business processes. Quarterly reports, annual closing reports, or balance-sheet indicators are transferred in electronic form to bank IT systems, where they are then processed by the corresponding rating applications.
Tighter business processes are also becoming more important for companies to fulfill the evaluation criteria. Given the higher credit conditions, incentive is growing for daily settlement of accounts and for comprehensive, IT-supported cash flow planning. The IT systems in controlling and accounting that handle these tasks increase the transparency of company data and enable correct and timely presentation of numerical data.

Dr. Christoph Rechtien

Dr. Christoph Rechtien

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