The purpose of this seminar is to give you a good understanding of how a comprehensive capital planning process can enable bank management to determine the appropriate amount and composition of capital needed to support a bank's business strategies across a range of potential risk scenarios and outcomes.
We start with a brief review of recent trends within financial risk management. We trace the progression of risk-management techniques, from "duration management" via ALM to Enterprise-wide Risk Management. We define the concept of "internal capital" (or "economic capital"), and we explain in depth a number of approaches to calculating the amount of capital required to maintain a certain solvency level.
We then proceed to explain the four fundamental components of a sound capital planning process suggested by the Basel Committee.
First, we describe how to establish a formalised capital planning process and explain how this process should be administered through an effective governance structure.
Second, we discuss the role of a capital policy in codifying guidelines that senior management will rely upon in making decisions about capital deployment or preservation. We explain the importance of and methods for sufficient risk capture, and how a capital policy can be established with reference to capital- and performance-related metrics such as "economic capital" and "RAROC". We also explain and demonstrate how "internal capital" can be efficiently allocated to different business lines and how risk-adjusted performance can be monitored.
Third, we explain how forward-looking measures about potential capital needs van be effectively incorporated into a bank's capital planning process. We explain and show how stress testing and/or scenario analyses can be used to obtain a forward view on the sufficiency of a bank's capital base.
Finally, we explain and demonstrate how a formal management process can be established to consider and prioritize actions that could be taken to preserve capital. Methods include reductions in dividends, equity raises and/or balance sheet reductions.
