Implementation of Basle II Capital Accord 2005 and its impact onto SMEs under consideration of rate
Implementation of Basle II Capital Accord 2005 and its impact onto SMEs under consideration of rate of equity pov I Introduction and executive summary 2 I. ... 2 Scope of Work 2 II Basle II and its impact onto SMEs 2 II.1 SME 2 II. ... 1 The position and importance of SMEs 2 II. ... 2 Current situation of capital resources under consideration of the 2 II. ... 3 Statistic of insolvency of SMEs 2 II.2 Basle II 2 II. ... 1 Current Basle accord in practise 2 II. ... 2 Merits and weaknesses of the current Basle accord (Basle I) 2 II. ... 3 The new framework for capital adequacy 2 II. ... 4 Rating under Basle II 2 III Practical consequences for SMEs 2 III.1 Capital management of SMEs 2 III. ... 1 Influence on capital portfolio 2 III.2 Information policy of SMEs 2 III. ... 3 Implementation of management information systems 2 III.3 Business policy of SMEs 2 III. ... 2 Implementation of risk management systems 2 III. ... 3 Changing objectives to achieve better ratings 2 IV Influences of the new Basle capital accord on capital management of SMEs 2 IV.1 Capital portfolio 2 IV. ... 2 Venture capital 2 IV. ... 3 Mezzanine capital 2 IV. ... 2 Costs and risks of different capital portfolio models 2 V Recommendation and conclusion 2 VI Literature 2 Table of figures: Figure II?1: Classification of SMEs 2 Figure II?2: Impact of SMEs on the economy of the EU 2 Figure II?3: Employment by size-class 2 Figure II?4: Share of equity in total balance sheet by enterprise size 2 Figure II?5: The three pillars of Basle II 2 Figure II? ... 1: Different aspects of the consequences of Basle II for SMEs 2 Figure III?2: Relation of Basle II, the banks, SMEs and the charged interests 2 Figure III?3: Example of the capital portfolio of a SME 2 Figure III?4: Implementation of a management information system 2 Figure III? ... 1: Composition of Capital Portfolio 2 Figure IV? ... 3: Venture capital and its sources 2 Figure IV?4: Mezzanine capital 2 Figure IV? ... 8: Risk and costs of equity and debt 2 Table of Abbreviations: SME Small medium sized enterprise EU European Union roe rate of equity Basle II Basle capital accord II EUR Euro cp. ... 1 Executive summary This study is concerned with the impact of Basle II onto small and medium sized enterprises with a special focus on the rate of equity. SMEs in Germany as well as in Europe have an important status. ... 6% of all companies in Europe are represented by SMEs. ... from 2001 to 2002 make clear the serious situation of SMEs. A reason for this high number of insolvency can be seen in the relative low rate of equity among them in the EU. ... The revision of the current capital accord throughout the „New Capital Accord“, which is still in its third consultative package, may endanger the current serious situation of SMEs. ... The concept consists of a minimum capital requirement, a supervisory review process and the consideration of market discipline. ... Currently there are three points an entrepreneur has to consider: § The capital management § The information policy § The business policy The change of an SME into a transparent company including a good running information system between bank and enterprise may be a first step into the next decades of an enterprise, which has to cope with several consequences of Basle II. ... Private equity from the entrepreneur himself or venture/mezzanine capital from an external investor helps to increase the enterprises‘ equity. ... This study makes clear the high need for SME to gather more information on the impact of Basle II on their finances. ... 2 Scope of Work This assignment deals with the influence of Basle II onto small and medium sized enterprises. Therefore the main basics of the position and the role of SMEs and the Basle II capital accord are presented at first in chapter two. The process from the first Basle capital accord to Basle II and the key content is described. Chapter three gives an abstract of the main consequences for SMEs out of this capital accord. ... The influences on the capital management, the impact on the information policy and the business policy of a company. The transparency of a company opposite its house bank and the relationship of these two partners are mentioned. ... In chapter four we are going into detail with the first mentioned part of the consequences: The Influences of the new Basle capital accord on the capital management. To x-ray this main part it is necessary to check a few of the many possibilities to increase capital resources to enlarge business. ... The first part deals with the capital portfolio of a SME and how it can be split up. ... At first it is researched whether there is the option to increase equity for example in form of private equity, venture capital or mezzanine capital. At second the possibility to change something in achieving debt capital is discussed. ... To end up this chapter and to give a widespread overview it is mentioned how these capital management consequences can be valued concerning the cost of the capital resources and the risk the management is dealing with by increasing capital in the different ways. Chapter five gives a recommendation how to deal with the impact of the new Basle II capital accord. ... II Basle II and its impact onto SMEs II.1 SME The definition of small and medium enterprises (SMEs) in all EU countries has been very different. In 1990 the European Commission established a European definition of SMEs. It consists of four parameters: § The number of employees § The annual turnover § The balance sheet total § The independence of SMEs The number of employees is counted by annual work units, which represent the annual full-time headcount. ... The independence means a limited influence of the shareholders in regard to the Capital and the voting rights. These facts lead to the following classification : Figure II?1: Classification of SMEs Obviously the main focus of the European Commission lies on the need of companies to gain funding. The „Basle Committee on Banking Supervision“ gives another definition: In this definition a SME is a company with an annual turnover of less than EUR 50 million. In comparison to the definition of the European Commission the Basle Committee does not take the number of employees and its balance sheet into account . The focus of the Basle Committee in regard to financial sources and demands of SMEs is generally on risk. II. ... 1 The position and importance of SMEs In regard to the amount of the SMEs in Europe, the impact of SMEs on the European economy is very strong. ... § In European countries 99 % of all companies are SMEs, which employ approximately two thirds of all employees . ... The following table shows the impact of SME on the economy of the EU countries: Figure II?2: Impact of SMEs on the economy of the EU There is no doubt about the economic relevance of SMEs in Germany as well as in Europe. Figure II? ... II. ... 2 Current situation of capital resources under consideration of the rate of equity The financing of SMEs can be provided by various sources. ... Equity can be defined as capital provided to the SME by the owner. ... Among these, there is a wide difference between the equity shares of SMEs. The following table shows seven countries with a variation of equity shares concerning the size of a company : Figure II? ... II. ... 3 Statistic of insolvency of SMEs The number of insolvency of German enterprises in 2002 reached a new record level with 37. ... 9 % of the enterprises were insolvency, employed under five people. ... This growing number of insolvency of SMEs is closely related to the problem of adequate financing. ... These facts of a low rate of equity and a preferred source of external financing of the enterprises makes the national law as well as the entrepreneur think about certain changes in the next time . II.2 Basle II II. ... 1 Current Basle accord in practise Since the „Basle Committee on Banking Supervision” published its first Capital Accord 1988, banking business management and certain supervisory approaches have not been taken under serious consideration by banks and entrepreneurs. The focus of the Capital Accord 1988 lay on the total amount of the bank capital, which was vital in reducing the risk of bank insolvency and the potential cost of a banks failure for depositors The Committee has been working on risk measures and on ways to make capital requirements dependent on the risk incurred by the respective bank. The reason was a certain way of capital regulation not to create risk-taking incentives. The Basle Capital Accord („Basle1“) tries to address this dependency and requires internationally active banks to hold capital equal to at least 8 % of a basket of assets measured in different ways according to their risk . II. ... 2 Merits and weaknesses of the current Basle accord (Basle I) The current Capital Accord 1988 was a regulation system to ensure an adequate level of capital in the international banking system while building business volume with an adequate capital backing . The merits of this Accord were recognised and became an accepted standard in banking systems in over 100 countries. But this existing framework only focussed on the total amount of bank capital. ... That means the focus of this accord only lies on a single risk measure but does not take into account other potential risks. ... This type of „one size fits all“ did not sufficiently recognise certain credit risk mitigation techniques and misses stronger risk sensitivity in its broad-brush structure. II. ... 3 The new framework for capital adequacy In general the „ Basle Committee on Banking Supervision“ has been deliberating new guidelines for regulatory authorities with the aim of removing the dysfunctional incentives. The first consultative package on the New Capital Accord was released by the Committee as a proposal in order to replace the current Accord 1988. This proposal was taken into consideration by the industry and by supervisors’ worldwide. ... These results of these efforts are the „New Basle Capital Accord“ released in form of the third consultative paper . At the end of 2003 the Committee seeks forward to publish the final document with the aim to implement it in the member countries and to take effect by the end of 2005. ... The new framework Basle II contents a variety of several approaches ranged from simple to advanced methodologies to measure with credit risk and operational risk in order to determine certain capital levels. ... Basle 2 is based on three pillars, which together should contribute to safety and soundness in the financial system: § Pillar 1: minimum capital requirement § Pillar 2: supervisory review process § Pillar 3: market discipline Figure II?5: The three pillars of Basle II The committee stresses, the need for rigorous application of all three pillars and plans to work actively with fellow supervisors to achieve the effective implementation of all aspects of „The New Capital Accord“.