Capital Planning: It's Not Just for Problem Banks

By William Harrison

Capital planning discussions between bankers and regulators are nothing new, but they have changed in recent years. Five or six years ago, the discussion probably sounded something like this:

Examiner: “I see in your strategic plan that you’d like to grow 10 to 15 percent per year over the next five years. Can income and capital support this level of growth?”

Banker: “Sure. Many of our shareholders want to buy more shares, and our directorate could easily provide up to $3 million if we needed it.”

In the past year or so, however, the discussion has become more like this:

Examiner: “I see you have a capital policy that states your intention to maintain a well-capitalized position. Your current ratios far exceed those limits now, but what if capital ratios drop to near the minimums? Then it might be too late to initiate your strategy.”

Banker: “Well, what do you suggest? Where is the guidance?”

That’s a great question. Where is the guidance? The Commercial Bank Examination Manual (section 3020 on capital) shares a basic premise that an institution’s capital should support the activities of the bank. This becomes a great starting point when considering your capital planning process. SR Letter 09-4 (Applying Supervisory Guidance and Regulations on the Payment of Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding Companies) addresses capital, but more from a holding company perspective. SR letter 07-1 (Interagency Guidance on Concentrations in Commercial Real Estate) details the need for more robust risk management practices and the need for more capital if you’re going to have sizable investments in commercial real estate. While both of these guidelines reference capital, however, they do not directly address capital planning.

So, is capital planning really that important? Absolutely. Your business strategies and risk need to be aligned with your capital plan. Capital planning does not have to be complex, and your plan does not have to mirror the plans of your competitors. No two banks are exactly alike or have the same risk appetite. Your analysis should be forward-looking and complement your existing risk management framework. It should also extend out several quarters and address the impact of such planning on the bank (and bank holding company, if applicable) and other stakeholders, such as shareholders, depositors, and regulators.

The main things to consider are the basic best practices. You need to consider a variety of factors, including the impact on both the balance sheet and income statement. Essentially, your capital position should be closely linked with the risk profile of your institution. Many capital plans include the following three characteristics:

  1. Identification of the need for or causes for capital planning (e.g., economy, interest rate assumptions, riskier business strategies, increased classified assets and loan losses, concentrations in loans and investments, rapid asset growth, insufficient earnings retention, etc.)
  2. Establishment of targeted ratios under various stress scenarios (e.g., increase capital ratios by 50 basis points if classified assets are greater than 40 percent of capital, or increase capital 100 basis points if the Allowance for Loan and Lease Losses is inadequate according to the methodology. These figures are for illustration purposes only.)
  3. Having capital restoration plans (short-term and long-term)

Short-term (30-120 days):

  • Restrict asset growth, especially in risk-weighted assets of 100 percent
  • Cease expansion plans
  • Plan to sell loans or engage in participations
  • Sell securities that are risk-weighted 100 percent
  • Suspend shareholder and other dividend payments

Long-term (generally contingent on market conditions):

  • Rights offering
  • Public offering (provided there is any interest)
  • Conversion of debt
  • Preferred stock issuance (provided there is any interest)
  • Issuance of subordinated debt (if not too expensive)

Lastly, be prepared for your next safety and soundness examination. The process for rating the capital component at your bank has evolved over time. It has gone from a point in time ratio analysis and assessment of balance sheet risk, to a more comprehensive and forward-looking analysis of management’s effectiveness at anticipating and reacting to changes in economic, industry, and regulatory environments. Additionally, it’s important to remember that examiners expect your planning efforts to follow the premise that your capital position should be commensurate with your risk profile. If you don’t have a capital plan, discuss with your directors the need to initiate a plan and incorporate it into your long-range strategic goals. Remember, capital planning is a must, not just for problem banks, but for all banks.

William Harrison is a supervisory examiner with the Federal Reserve Bank of Richmond. He can be reached at

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