Following the financial crisis banks – and their supervisors – are monitoring closely the wide range of regulatory key performance indicators (KPIs) that have been introduced. All of these are of more or less equal importance, since as a violation of any one of them may cause supervisory action, and in extreme cases more severe and formal disciplinary actions.
The simultaneous management of these KPIs is of particular importance from a capital management perspective, because an investor’s view of the “value” of a bank will be materially determined by discounted future distributions and potential supervisory restrictions on dividends and distributions.
Indeed, regulatory and supervisory determinants are playing an increasing role in investors’ views of the distributable profit of a bank, besides the “traditional” macro, market and business factors.
Beyond the “core requirements” from CRR/CRD IV on regulatory capital, the main new regulatory and supervisory indicators are:
As the supervisory law provides for distribution restrictions1 and all stated factors and indicators are concurrent and must be complied with at any time, regulatory capital is one of the major parameters with regard to the valuation of banks. This capital distinctively determines distribution capability. Moreover, the regulatory requirement may change very quickly, for example as a result of stress testing, while bank balance sheets can respond only slowly to management action. Changing course can be undertaken only according to a certain time frame.
Considering such a complex system, it is necessary, but not always easy, to answer questions such as: How high is the added value provided by an individual financial product? Which indicators are influenced by which products? In which direction? For example, raising fresh deposits to invest in a government bond should influence the interest margin positively – at least if there is a generally positive interest rate level. This will also benefit the liquidity coverage ratio. However, the leverage ratio would decrease. Thus, it needs to be evaluated individually whether this investment earns its capital costs taking into account the risk, costs of refinancing and maturity transformation.
In order to be able to manage a bank balance subject to such a wide range of constraints and frameworks in a forward-looking way, certain elements are necessary:
If there is such a value and risk driver tree, it may be used to validate simultaneously the influence of business activities on various indicators not only with regard to the regulatory, but also to the financial indicators. This should provide a solid basis for management and planning; and for the simulation of various stress scenarios, which are increasingly gaining importance in the regulatory context. Such a planning and management approach would therefore also support the strategy discussion and the solution of the aforementioned optimization problem with regard to increasing the company value – and thus ultimately result in a more solidly founded business and risk strategy, which must be detailed enough to be able to reflect both the variety of the requirements and the variety of the banking businesses. This should result in banking businesses without surprises with regard to their influence on financial and regulatory indicators, and in an increased trust of all investors and stakeholders.
1One recent example: At the beginning of 2015, following the Comprehensive Assessment (CA), the ECB published a recommendation in which it asked banks to forgo distributions if the capital targets of CA were not met. If the CA target was met, but the entire capital requirements of CRR were not yet met after the transitional arrangements, only a very prudent distribution should be carried out and the way towards full compliance should be clearly demonstrated.