Three significant events have altered expectations for capital plans. First, as of January 1, 2015, banks need to comply with the new BASEL III capital requirements, including the new “capital conservation buffer.” Second, regulatory authorities now view strategic planning and capital planning as risk appetite and risk mitigation documents, respectively. Finally, the demise of the market for trust preferred securities has reduced the ability to raise just–in–time capital, which was a prevalent concept from 2005 to 2009.
Every board should ask the hard question of whether or not the depository institution has sufficient capital to (1) address BASEL III regulatory requirements, (2) navigate the current economic environment, and (3) implement the desired strategic plan for the depository institution. If the answer is no, management should focus on how much capital is needed, and the board and management should determine the sources for funding those needs.
Even if you currently have a capital plan, it may not “chin the bar” with the regulators. Traditional two–page or five–page capital plans are falling short of what regulators expect to see in capital plans. Such plans are now becoming much more robust and are truly a management planning tool rather than simply something that is “nice to have.” A strong capital plan is a critical document, as it ensures that there is enough fuel to drive the bank’s strategic plan and ensures that there is adequate insurance against the bank’s risk profile. Every depository institution, even healthy depository institutions, should have a comprehensive capital plan that dovetails with its strategic plan and its enterprise risk management plan.
The regulatory agencies are clearly steering institutions away from the concept of just–in–time capital that resulted in many depository institutions finding trouble in 2008 and 2009. Some regulators have even hinted that a comprehensive capital plan may soon be an integral part of the safety and soundness examination process, perhaps showing up as an element in the capital or management component of the CAMELS–rating system. Some of our clients have already received questions in this regard in light of upcoming regulatory examinations, so it is likely a trend that will only continue to become more frequent and ultimately a requirement.
The breadth and depth of a comprehensive capital plan will, of course, depend on the risk profile of the depository institution. While there is no magic outline for a capital plan, almost all capital plans should have a few critical components: (a) background on the depository institution’s strategic plan, operations, economic environment and current capital situation, (b) tolerances and triggers, (c) alternatives for available capital, (d) perhaps a dividend policy and (e) financial projections.
The tolerances and triggers may be the most important part of the capital plan, as this is how the institution will avoid needing just–in–time capital. The identification of tolerances and triggers operate as an early warning system to alert management that capital may become stressed in the near future. Careful planning should take place when considering what the tolerances and triggers will be, as these are the key drivers in making the capital plan a true planning tool.
In summary, capital planning is an important, if not necessary, tool for any depository institution, regardless of condition. There is a growing sea change in how the regulators view the necessity of a capital plan, and a growing expectation that every depository institution have a viable capital plan. It is important to note, however, that there is no one–size–fits–all capital plan that can be pulled off of a shelf as a form document. Instead, the plan should be carefully considered and evaluated, either as part of the institution’s strategic plan or as a separate plan working in tandem with the strategic plan. Finally, after it is prepared, the capital plan cannot simply sit on the shelf, but should instead be treated as a living, breathing document that will need to be revised as the economic and regulatory environment, risk profile, strategic direction and capital resources available to the institution change over time.