CAPITAL PLANNING process
OVERVIEW OF KEY CAPITAL PLANNING STEPS
In your capital planning process, start with basic, simple approach. Only move to more complex steps as you see need - and add value.
A key step is translating your strategic business plan into a financial forecast. Use at least two scenarios.
From these forecasts, you can identify capital issues that will drive dividend and capital management actions.
current assessment of financial position
Your finance team in conjunction with other members of your organization should prepare a current assessment of your financial position.
This current assessment should include reviews of profitability, capital adequacy and dividend capacity, interest rate risks, operating and capital expenditures, liquidity, loan activity and trends and loan and asset quality.
FIVE-YEAR FINANCIAL PROJECTIONS
While long term financial projections are based upon numerous assumptions which are difficult to make, it is very important to have a longer term view of your expected financial performance as a baseline for evaluation and discussion.
While forecasting for longer periods of time is more art than science, a time horizon of five years provides a better framework for discussing issues today that may not need addressing for several years - but gives you the control over when to take such action. A shorter time frame - such as two years - may not provide you with that opportunity.
risk ASSESSMENTS
A risk assessment is a critical element of your capital planning.
What are identified risks that you are or will be facing - credit, interest rate, liquidity, price, operational, compliance, strategic, and reputation?
What are emerging risks that could develop? There will be risks that are deemed unlikely - who foresaw COVID-19 and its impact.
How do you evaluate your capital adequacy, given these known and emerging risks?
What is your risk appetite and your risk philosophy and is your capital plan consistent with those views?
What risks can be reasonably quantified?
While you will build your strategic plan and your capital plan on your "most likely' view of the future, you should consider additional scenarios.
For example, if the U.S. economy is beginning to age historically, you may want to create a scenario that assumes a slowdown or recessionary environment. This may also assist you in re-thinking your "most likely" scenario.
Or there could be more local or regional issues such as housing price bubble or energy boom or agricultural recession that could have a possibility of occurring and worthy of a scenario assessment.
MULTIPLE SCENARIOS
Your Capital Plan should also include your key capital policies and validate that your Capital Plan is compliant with those policies. Examples of capital policies include capital adequacy, dividends, debt limits, etc.
Likewise, if your capital policies need to be revised or updated, this would be an appropriate time to do so.