Planning for profitability
Regulatory demands and improved profitability are fuelling a move to dynamic capital planning, but few banks have firm plans, writes Tom Groenfeldt.
According to Alwin Meyer, chief operating officer, risk and performance management for SunGard’s banking business, Banks are moving toward more dynamic capital planning both to meet regulatory demands and to improve profitability.
“Regulators are certainly a main driver,” said Meyer. “However, what we see is that banks are undertaking capital planning to ensure their profitability.”
A survey of banks by Chartis Research on behalf of SunGard has found that although banks across the globe are placing greater emphasis on capital planning and stress testing, few have well formulated and defined plans in this area.
The survey, which covered 146 industry practitioners, found that banks are ranking capital planning as their highest priority. Many don’t, however, seem to be in any rush to actually do anything about it. Over 45% of respondents confirmed that their current capital planning programmes are not fully defined and had only partial sponsorship from the board of directors.
A cultural shift towards capital planning must occur to help ensure banks have the necessary frameworks to effectively manage capital and help address current and future regulatory challenges, advised Chartis.
“Capital planning is becoming more and more strategic,” explained Peyman Mestchian, managing partner at Chartis, speaking at a SunGard conference recently. “Capital planning used to be an annual planning cycle. Now annual has become quarterly or monthly and in some banks it is daily and intraday.” Doing capital planning once a year in the modern financial world is a little nonsensical, he added.
Still, dynamic capital planning is at best a work in progress: “When we asked the banks how they would characterise their current capital planning, only one quarter said it was well formulated and systematic.”
The Chartis report says they should get moving because regulations will require them to. Some of the findings had a familiar, even historical, feel, such as the conclusion that “banks will also seek to rely less on traditional performance based measurements, and to move towards more risk-adjusted performance metrics.” RAROC anyone?
Chartis said that while banks are directing their risk management to regulatory demands, they should also be looking at improving risk management to improve profitability.
“Basel III, the Dodd-Frank Act, and other domestic post-crisis regulations are not going away and regulation will remain a major constraint on banks and will keep the cost of capital high. To adjust to the post-crisis financial environment, banks must adapt their capital management and capital planning programs not only to comply with regulations, but to improve the efficiency of their use of capital.”
Mestchian said that many chief risk officers who were interviewed shared their pain around the sheer volume of regulatory requirements, especially in compliance and capital adequacy.
“Many risk people felt they were spending too much time on compliance and not having enough time for day-to-day risk management; that could be an unintended consequence.”
Top concerns were skewed toward regulatory compliance with capital planning, including capital stress testing followed by calculation of regulatory capital and regulatory capital adequacy reporting.
The emphasis on regulatory capital adequacy has short-changed economic capital, capital allocation and might hamper efforts to use capital efficiently to price risk, Chartis reported. The report does not ask why banks don’t simply assign more resources to capital planning so they can cover both regulatory requirements and business requirements such as risk management and cost reduction.
“Banks operate today under enormous pressure on their margins from various angles, putting their profitability at stake,” said Meyer.”Risk management and compliance remains a focus investment area and is still expected to get significantly increased budgets compared to 2012 according to a review performed by Risk magazine in late 2012. Nevertheless the ever increasing regulatory burden absorbs existing and additional funds in a way that puts the genuine risk management tasks at stake.
Kirk Wylie, founder and chief executive of the London-based risk management firm OpenGamma, agreed with Chartis that banks can’t do both.
“One reason is that the requirements keep changing. We still don’t have confirmation on exactly how Dodd-Frank will play out and Basel III is a shifting target,” said Wylie. “Staffing is a problem because there is a fixed number of people industry-wide who have the quantitative and business knowledge to be able to work in these areas.”
Capital planning does enjoy high-level attention with responsibility roughly divided between the chief risk officer and the chief financial officer, or the demand side of capital and the supply side, according to the report. It would probably help if banks understood what capital planning is – 45% said it is not fully defined, 26% thought it was tactical and a tiny 2.4% had no current process in place.
To achieve good capital planning, banks will need to invest in IT and systems. Chartis said that “data systems are largely inadequate because they are often piecemeal, rather than part of an integrated whole. Moreover, investment in these systems is hard to come by, because the business case of long-term savings through IT has not been heard.