The most important lesson learned as a result of the recent financial crisis was that the U.S. banking system did not have sufficient capital in 2007-2009 to support the risks in the system. The regulatory reaction to the financial meltdown has been to ramp up bank capital standards across the board. Minimum capital standards are no longer derived from the “Prompt Corrective Action” rule under banking regulation but are in reality 2% above what the regulations require in order to be considered a well-capitalized bank. We expect that new regulatory standards conforming to Basel III will be adopted by all of the U.S. banking regulators, with most of the new standards applied to all banks regardless of their asset size.

Capital planning needs to become a key part of the bank’s ongoing strategic and business planning process. Bank management and the Board need to consider the metrics for measuring their bank’s capital levels and the minimums they are comfortable with maintaining.

We recommend that banks in mutual form maintain higher capital levels than stock banks because of their limited and cost-prohibitive access to external sources of capital.

Banking regulators are recommending a strategy of building capital levels well above the regulatory minimums for a well-capitalized bank during periods when the economy is growing robustly and bank earnings are strong because the risks in the bank’s operations and balance sheet are also increasing during these growth periods. Historically the banking industry has leveraged its increased earnings with aggressive asset growth and stock banks increased their dividend payout rates to support their stock price. This is where the planning process is important – if growth is projected to be strong and earnings robust, what level of capital should be maintained to protect the bank in a declining economic environment when asset quality may become a strategic issue?

If you would like more information about the development of a Capital Plan for your institution, please contact us.