Author: Adam Mustafa, CEO
When it comes to capital, community banks often lean on conventional wisdom, which may work for now but could limit their growth and adaptability in the future. Many CEOs confidently assert that holding 10%, 11%, or even 12% capital is the conservative approach that helps their boards sleep better at night. While this may seem prudent, is it truly optimized for the challenges ahead?
The Cost of Being Overly Conservative
Holding excess capital comes at a cost. Every dollar beyond what is necessary earns a 0% return for shareholders, representing untapped potential. This conservative stance, while comforting, may not align with a bank’s long-term goals, particularly in an environment where justifying independence hinges on generating sufficient returns for investors.
The reality is that balancing capital adequacy with shareholder returns requires precision, not blanket approaches. Banks that hold "comfortable" levels of capital may be missing opportunities to reinvest those funds to fuel growth, create value, and enhance their return on equity (ROE).
Navigating the Regulatory Safe Harbor
Many banks defer to the regulatory “safe harbor” for capital adequacy, but this can be a dangerous gamble. Over the years, regulatory expectations have gradually shifted, often without clear or consistent benchmarks. What was considered safe at 8% a decade ago now edges closer to 10% or higher, depending on examiner expectations. Relying on these ever-shifting goalposts can lead to suboptimal capital allocation.
A Case Study: The Power of Precision
Consider a $1 billion asset bank that faced an impending examination. Instead of passively accepting a regulatory benchmark of 9% capital, the bank chose to perform a detailed analysis of its unique profile, simulating stress scenarios to determine its true capital needs. The results? Their analysis revealed an optimal requirement of 8.2%, freeing up an additional $9.4 million in "dry powder" capital compared to the regulatory benchmark.
This precise approach enabled the bank to reallocate capital effectively, bolstering growth opportunities without compromising safety. The difference between adhering to a generalized rule and tailoring capital requirements based on data-driven insights can significantly impact ROE and overall financial performance.
The Fiduciary Duty to Optimize Capital
Bank management teams have a fiduciary responsibility to maximize the efficiency of their capital. This means striking the right balance between defensive reserves and offensive investments, particularly during periods of strength. Engaging in this analysis now, while conditions are favorable, allows banks to prepare for growth and maintain independence without unnecessary risk.
Optimizing capital isn’t about abandoning conservatism—it’s about making every penny count. By leveraging data and foresight, community banks can unlock new avenues for growth, enhance shareholder value, and strengthen their position in an increasingly competitive landscape. After all, the best time to prepare for the future is when you don’t need to.
Invictus Group is here to provide strategic guidance and tailored solutions. With expertise in stress testing, capital planning, and risk management, we empower banks to thrive, even in turbulent times. For more insights, visit our website or follow Adam Mustafa on Linked in.
