Now is the time to prepare, as tougher regulatory scrutiny of capital levels is coming.
By Monica C. MeinertThe high-profile failures of Silicon Valley Bank, Signature Bank and First Republic have prompted a wide-ranging discussion on the future of bank supervision and regulation. Add to that a long-awaited “Basel III endgame” proposal recently issued by the banking agencies, and it’s clear that banks should be bracing for changes in the regulatory capital framework in the days ahead.
But determining how much capital a bank needs is a complex challenge—made even more complex by the current climate.
How much capital is enough “is a deep philosophical question,” notes Anthony Donatelli, EVP and director of strategic planning, capital planning and stress testing at New York Community Bancorp, speaking on a recent panel at ABA’s Risk and Compliance Conference. “There are a series of stages and steps you want to look at in terms of assessing and determining how much capital is enough relative to your institution.”
First, he notes, banks should consider their constituents and their expectations—entities like ratings agencies, analysts, home loan banks that might have specific capital requirements, and others. From there, he says, “you look at who you are as a bank relative to a peer group.”
Another component of the equation is stress testing. “The whole reason for stress testing is to understand the amount of (capital) depletion through a stressed environment,” Donatelli says “That amount is what you want to ensure that you have … to provide a cushion within some type of stress.” Banks should also maintain a capital buffer above and beyond that amount—but it’s a delicate balancing act, especially as banks are falling under closer scrutiny from not only regulators, but also analysts and the media in the wake of the spring failures.
“Raising capital is hard right now,” acknowledges Todd Pleune, managing director at Protiviti. “You don’t want to be the next target of short sellers.”
For banks that find themselves in need of additional capital but are concerned about optics, Pleune sees an avenue to use the anticipated regulatory capital changes as cover. “You want to be proactive. Put plans out there so analysts know what you’re thinking of doing. Give things time to percolate,” he says.
Donatelli agrees. “You want to have a basis for that capital raise,” he advises. “If you’re going to take that leap (and) be a first mover (in raising capital), you need to understand and explain why that is.”
Failing to adequately explain the rationale behind a capital raise could have repercussions in terms of public perception, he adds. “Rather than have the marketplace with social media tell your story, you want to control the narrative. The more you do that, the better positioned you’ll be in terms of mitigating concern.”
In Pleune’s view, though, capital wasn’t the culprit in the recent bank failures. “The banks that failed had high concentrations in unique areas: They had unrealized losses, and a disconnect between regulatory capital and what the investors were focused on.” As banks assess their own balance sheets, he encourages them to “think proactively about what are the indicators of your specific risks. What are the risk drivers at your bank? How do you monitor that, and how do you be proactive about fixing those risks?” Whether that’s by raising capital, hedging unrealized losses or another alternative.
One factor that was a key contributor to SVB’s collapse, however, was rapid deposit flight—and that’s something banks need to consider moving forward. “We are in a new world,” says ABA SVP Hugh Carney. “Deposits are moving quickly. In general, uninsured deposits and deposit runoff rates, specifically within the liquidity coverage ratio, are going to be reevaluated.”
Donatelli, Pleune and Carney all agree that banks can expect to see greater regulatory scrutiny across the board in the months ahead. “Regulators are going to become more global in terms of trying to put different types of scenarios in play that become more of a departure from everything just being recession based,” Donatelli says. “If you’re standing still, waiting for them to do something, you’re going to be in a world of hurt. They want to see you taking action.”