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Making demands for adequate capital - Views on News from Equitymaster

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  • Nov 18, 2008

    Making demands for adequate capital

    Regulation at the cost of profit
    One can expect to see more regulation in the financial system after the unraveling of the crisis which is being touted as the worst since the Great Depression of the 1930s. One of the key requirements will definitely be that banks should harbour adequate capital. This was emphasised all the more in the G-20 summit which saw the leaders of the biggest developed and emerging nations participate.

    Not surprisingly, amidst this ongoing crisis, the participants of the summit pointed fingers to banks, imprudent investors who sought high yields without fully understanding the risks and the regulators who failed to address the danger bubbling in the markets. As a result, these leaders are now demanding that banks, hedge funds and credit rating firms maintain strong risk management systems and adequate capital which means that the potential for profits is likely to get scaled down going forward. And the ones who are likely to come under intense scrutiny will be financial companies with presence across borders.

    Just to give a perspective of how bad things are, as reported on Bloomberg, a report by the Bank of England published last month showed that capital ratios at US commercial banks plunged to less than 10% of assets from over half in the mid-19th century. Of course, while stricter regulatory practices are definitely the order of the day to ensure that a financial volcano of such magnitude does not erupt again, governments across the world have to also make sure that in their zeal they do not end up 'over-regulating'.

    Biotech's innovation thwarted
    Biotechnology in recent times had evinced a lot of interest from pharmaceutical companies due to the higher accuracy in treatment as compared to chemical drugs and the potential therefore to earn higher revenues and profits. In fact, in a scenario where the R&D pipelines of global innovator companies were drying up and blockbuster drugs (those earning revenues above US$ 1 bn) were getting that much more harder to develop, the focus had shifted to biotech drugs, which would address only specific medical needs (thereby entailing a smaller target population) but with higher accuracy. This had resulted in the mushrooming of many small biotech firms. And the importance of this field was further highlighted when big innovator companies were on the prowl to gobble up some of these firms.

    Now the global financial crisis has not spared these small firms too. Strapped for cash, many of them have already started laying off staff adding to the already bloating unemployment population in the US and are shelving many of their research projects. The problem does not end there. Many of the biotechnology stocks have seen their market capitalisation erode as risk averse investors are shying away from making investments in these companies given the high risk nature of these businesses as the probability of the experimental drugs failing is high. Cash is the lifeline of these small startups and in the current scenario the only way for them to stay afloat is infusion of money into them by large pharma companies.

    But that is easier said than done. As the financial turmoil continues to persist and the pressure to introduce low cost drugs continues to mount, large companies already have their own problems to deal with. Whatever the case may be, biotechnology projects which are the hallmark of innovation in medicine are certainly set to take the backseat till such time that the financial crisis subsides. When that will happen is anybody's guess.



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