It is widely believed that the sensitivity to various economy-wide factors, and hence the rate of business failure, vary by industry. Some industries are obviously more risky than others; for example, compared to utilities, mining and oil exploration would be considered subject to a higher risk of business failure. Financial institutions are comparatively stable; however, significant concentrations in their investment and loan portfolios can make them vulnerable to changes in interest rates, foreign exchange rates, securities market fluctuations, commodity prices, and real estate values. Bankruptcies in the financial sector are few, but are by far the largest in size of average liabilities.

It is important to consider what impact economic conditions affecting an industry have on the risk of business failure experienced by a firm in the industry; for example, firms in an industry beset by difficult economic conditions, such as construction at a time of high interest rates, would face a heightened risk of business failure. Similarly, a commonly-cited concern about the financial sector is the potential sudden failure of not just one entity, but many others through a domino-effect, throwing financially sound entities into financial distress in the form of a liquidity crisis.

As discussed in connection with the Client screen, Risk Alert uses 8 categories of ratios to assess the economic state of the industry compared with all industries for which Risk Alert has data.

Regulated industries are often required to comply with a variety of financial and operational conditions. These conditions vary from industry to industry. For example: a trust company must operate within the leverage limit granted to it -- for many trust companies the ratio of capital and surplus to borrowings must exceed 5%; a life insurance company cannot place more than a specified percentage of its total assets in unsecured loans or other non qualifying investments; and a pension fund is restricted in the types of investments it is permitted to make.

There is a variety of regulations governing the types of activities that each regulated business may engage in and the related financial reporting requirements. Contravention of regulations can lead to the shut down of an entity by the relevant government body, analogous to, but potentially more serious than, the repercussions that follow contravention of debt covenants. Because of the potential repercussions of a failure by an entity to comply with regulatory requirements, such contraventions may be accompanied by management fraud or deceptive accounting practices to prevent detection of non-compliance by regulatory agencies and external auditors.

Disclosures about the various risks and uncertainties particular to an industry were recommended in the 1990 CICA research report entitled Approaches to Dealing with Risk and Uncertainty. Such disclosures can help make interested parties aware of the risks and uncertainties faced by an entity and, by implication, the investors and creditors.

Select the characteristics that best describe the client’s industry.