Capital Management in Stressful Times: Taking a Holistic Approach

Global economic uncertainty is once again prompting international banks to scrutinize their strategic planning and allocation of capital and liquidity across different activities, business lines and jurisdictions. Today many of them are coming to an uncomfortable realization: their approach to capital and liquidity management is inefficient and disjointed. The consequences of this can be significant, including heightened financial, operational and regulatory risk and expenditure on unnecessary or duplicative treasury operations.

Strategic capital planning was not a top priority immediately after the financial crisis because of constraints associated with the injections of capital by governments and supranationals, as well as uncertainty about new regulatory standards. Moreover, accommodative monetary and fiscal policies helped some banks bolster their liquidity and capital positions. Meanwhile, low interest rates and steep yield curves enabled banks to generate strong revenues, despite greatly reduced leverage.

While the interest-rate environment and fiscal policy continue to be supportive (at least for now), senior executives and boards are now faced with questions about volatile equities markets, sovereign debt and the potential for global contagion. Perhaps now more than ever before, bankers are looking holistically and dynamically at their capital and balance sheet risk due to a competitive landscape where investors and regulators will ask for stronger capital and liquidity ratios and greater assurance about the mobility of liquidity.

A strategic capital and balance sheet management structure will become even more critical to an organization as initial guidance on what will be expected of Systemically Important Financial Institutions (SIFI) is due this fall. A SIFI designation will require large banks to much more closely link business strategy and risk management to capital and liquidity management. From a strategic, longer-term perspective, having more discipline in the business service management process will prove to be a competitive advantage.

A non-integrated approach to balance sheet management makes it much more difficult for banks to create a coherent and dynamic picture of risk-adjusted measures of return on capital across their organizations. For a bank seeking to understand whether it makes sense to stay in a particular line of business or to define its optimal business mix, especially in light of changing market conditions and regulatory capital rules, an integrated approach to capital management is key.