Bank Capital Optimization - "Do More with Same"

The concept of Capital Adequacy lies at the heart of banking and is a critical indicator of the financial soundness of a bank. The evolution of Basel standards over time has made capital management increasingly stringent for banks.

Banks constantly face the challenge of meeting capital adequacy ratio (CAR) requirements to satisfy Regulators whilst having to achieve adequate returns (profitability) to satisfy Shareholders.

Capital Optimization occurs when bank capital is put to such prudent and efficient use that meets the expectations of Regulators and Shareholders simultaneously. Downsizing risk-weighted assets (RWA) to raise CAR without due regard to return on assets (ROA) may lead to a bank opting for an overly conservative (credit and investment) portfolio with inadequate profitability.

Capital Optimization is a multi-dimensional and transparent concept implying the optimal use of scarce capital in such manner that accounts for CAR as well as ROA, with due regard for the risk policies and risk limits for products, customers, groups, sectors, or countries that are prescribed by the Risk Committee and the Board of Directors.

Through Capital Optimization, we uncover the delicate mix of risk and return that would enable a bank to satisfy multiple stakeholders, including Regulators and Shareholders.

We encourage banks to implement Capital Optimization, which may be integrated within the Capital Planning exercise in the context of Internal Capital Adequacy Assessment Process (ICAAP). All complemented with the notion of Greening, to embed Sustainability in Capital Planning.

At OptiFin Solutions, we have concrete experience of recently advising banks on capital optimization, demonstrating how a pragmatic and feasible reallocation of portfolio may lead to higher return albeit with lower risk.