Capital and Liquidity Planning

Challenge: Banks, by their very nature, are highly leveraged businesses. But how much leverage is appropriate is not an easy question to answer but is essential to managing a bank effectively. To think about the issue another way, a bank’s bond holders would like it to hold as much capital as possible so as to insure that it does not default on its obligations. The equity holders, on the other hand, would like to see it hold as little as possible so as to maximize their returns. Striking the balance between these two competing perspectives is what capital management is all about. The effect of not planning for and managing the available financial resources can be catastrophic, causing solvency threatening liquidity crises.

Solution: ERisk will work with the banks management team to understand the current available capital and the variety of forecasts used for planning. We’ll use our economic capital analytics to help quantify the appropriate level of capital in these scenarios and identify the necessary assumptions to do so. We will then work with the finance and planning group to develop a plan for managing the capital and risk-adjusted return on it in the future. This will include looking at strategies for raising capital or those for returning it to shareholders to ensure that the RAROC of the bank is above the hurdle rate demanded by the market. This is the level of profitability required to enhance shareholder value while maintaining the solvency of the bank. Finally we will help the bank identify the process for managing capital levels on an ongoing-basis.

Benefits: A capital and liquidity plan provides a comprehensive and analytic basis for optimizing the leverage of a bank. This ensures that both the bond holders and the shareholders meet their goals and the bank’s ROE is enhanced.

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