S&P’s introduces risk-adjusted capital framework

Standard & Poor’s Ratings Services is introducing a risk-adjusted capital ratio for financial institutions.

Bernard de Longevialle, credit analyst at S&P, says: “The RAC aims to provide a globally consistent and independent view of capital adequacy for each of the financial institutions we rate.

“In our view, other risk-adjusted capital measures are increasingly issuer-specific–potentially making it more difficult to use them to compare banks–or less risk-sensitive than the RAC ratio.

“We have developed the RAC ratio to help us maintain ratings comparability and consistency, and we intend to use it as a starting point for our analysis of capital adequacy.”

He says the case studies it has performed using preliminary data it receives from 150 banks in the past 12 months suggest that the global banking system would be on average relatively weakly capitalized to weather the crisis scenario embedded in our risk-adjusted capital framework.

The case studies also show that the RAC ratio, after concentration/diversification adjustments, was on average 30% lower than the banks’ reported Basel II Tier 1 ratios, but more favorable in 10% of cases.

He adds: “In the U.S. our RAC ratios are expected to be significantly lower on average than regulatory ratios. The impact of concentration/diversification adjustments was between a 40% concentration charge for highly concentrated financial institutions and a 20% diversification benefit for the most diversified banks in our sample.

“We currently expect marginal rating implications upon adoption of this approach.

“The RAC ratio, which is the quantitative transcription of our qualitative analysis, is only a starting point for judging capital adequacy, and our assessment of capital adequacy is also only one of many factors we use in arriving at a credit rating.”

“We have also addressed what we see as the most pertinent investor questions about the new framework, in our article titled “Credit FAQ: Standard Poor’s Risk-Adjusted Capital Framework For Financial Institutions,”