The New Finance and Risk agenda

Capital management - New Challenges, New Opportunities

Introduction:

Increased sophistication and liquidity in the capital markets, advances in analytics and changes to regulation and accounting standards are forcing banks to change the way they manage their capital. As a result, it is becoming increasingly complex for the Chief Financial Officer (CFO) and Chief Risk Officer (CRO) to balance the needs and expectations of internal and external stakeholders. With management decisions regarding capital (allocation and productivity, capital structure and capital raising, balance sheet and risk capacity, dividend policy, etc.) becoming ever more integral to strategy, corporate development and investor communication, banks require a more cohesive and dynamic capital management process.

Leading banks are responding to this challenge by setting up dedicated capital management functions that typically report to the CFO via an extended Asset Liability Committee (ALCO) or balance sheet management unit. The establishment of a dedicated unit reflects the growing number of stakeholders involved and the increasing number of capital measures (regulatory, economic, accounting, etc.) that must be managed. The focused nature of this unit supports a more dynamic and integrated approach to capital management, thereby allowing banks to address the increased volatility in capital ratios brought about by changes to regulation, particularly to Basel II and IFRS.

The dedicated capital management function must be equipped with the appropriate tools and processes to measure and manage capital. From a measurement perspective, this means building up the necessary tools to forecast and stress test future capital and earnings positions; from a process perspective, this involves integrating capital projections into the processes of strategic planning and financial communication.

Advanced capital management teams create value for their organizations by identifying opportunities to deploy surplus capital as excesses arise, by actively managing the level and deployment of the bank's capital and by ensuring that mechanisms are in place to manage down risk and raise capital should a future capital shortage appear. Critically, these gains can only be realized if changes to the capital management process are embedded throughout the organization via the strategic planning process. This discipline must be further reinforced at the Board level through increased involvement in capital management decisions.

This report discusses these issues and is structured as follows:

• New Challenges: Why has capital management become so important?
• Industry Responses: What pragmatic changes has the industry been focusing on?
• Getting Started: If we agree with this, how can we get the activation energy to get moving on this?

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