The Basel Committee on Banking Supervision has issued a paper setting out sound practices to improve banks’ capital planning processes in an effort to foster overall improvement in the capital planning processes of banks required to implement the Basel III framework. The paper provides an overview of four fundamental components of a sound capital planning process, which include the following:
- internal control and governance;
- capital policy and risk capture;
- forward-looking view; and
- management framework for preserving capital.
The BCBS also explains some of the faults and lessons have been learned from the financial crisis, including:
- undoubtedly, banks must improve and strengthen their capital planning;
- banks need to examine their processes as in the past they were not sufficiently comprehensive, appropriately forward-looking or adequately formalised;
- banks must be careful of underestimating the risks inherent in their business strategies and, in turn, misjudging their capital needs;
- in the past, some banks continued to pay dividends and repurchase common shares when capital could have been retained to insulate them against potential future losses caused through a lack of comprehensive information;
- historically also, some banks issued large amounts of capital instruments, such as hybrid debt, that ultimately proved ill-equipped to absorb realised losses; and
- a large part of the problem was also that many banks did not scale their decisions about the level and composition of regulatory capital to the potential impact of changing economic conditions.
View A sound capital planning process: fundamental elements, 23 January 2014