Regulatory Focus on Strategic Planning Means New Analytics for Approval

While regulators are increasingly urging banks to focus on careful strategic planning, community banks need to know that traditional analytics won’t get their plans approved.  Comptroller Thomas J. Curry made that clear in an address  earlier this month when he advised community banks to “make sure that your capital plan remains aligned with your strategic plan.”

The Federal Reserve has also advised community banks that capital planning should be coordinated with strategic planning to give a more “holistic view” of the bank’s needs.  In “Capital Planning: Not Just for Troubled Times,” Jennifer Burns, Senior Vice President, Supervision, Regulation and Credit, Federal Reserve Bank of Richmond, wrote that a capital planning process “consistent with the bank’s risk levels and growth plans helps the board and management plan more effectively for both capital and business line decisions.”

Invictus Consulting Group chairman and founder Kamal Mustafa said in today’s regulatory environment “you have to change your analytics to do a strategic plan.” The reason:  Regulators can no longer extrapolate a bank’s future performance based on how it did in the past. They learned that lesson after the recession, which disrupted both the right and left sides of a bank’s balance sheet. While many banks have worked out much of their troubled loans, those workouts have taken place during an artificially low interest rate environment and jobless recovery.  And that portends problems in the future, when those new loans again come under pressure.

“Historical analytics that used a constant base are no longer valid,” Mustafa noted. “The whole base has changed and the fundamentals have changed.”

The only way to get a forward-looking view – which is what regulators now require—is to put plans and balance sheets through an extensive capital stress test.  The results can help community banks customize their regulatory capital requirements and determine how much FreeCapital™ they have for discretionary use.  Unlike the process for larger banks, community bank stress testing is relatively simple.

The stress test enables a bank to make sure that its strategic plan is, as Curry said, aligned with its capital plan.  It is that element that has taken stress testing out of solely being a risk management function and put it squarely in the boardroom.

The message that banks should focus on strategic planning has come from every federal regulator in recent months.  The OCC listed it as a main priority in its semi-annual risk perspective in June, noting that examiners would focus “on banks’ strategic business and new product planning to ensure appropriate risk management processes are established.”

The FDIC has mandated written “realistic, comprehensive strategic plans” in its recent consent orders, according to a review of 2014 enforcement orders. Most of those orders call for the banks to come up with new financial goals, “including pro forma statements for asset growth, capital adequacy and earnings.”

Careful strategic planning is the best way for community banks to get on a path toward success, Curry said in his Oct. 1 speech. “Strategic planning can help define how you want to position your business and service activities, identify your best opportunities, and provide guidance when you need to make hard choices about the unknown and uncontrollable,” Curry said.

The OCC’s final rule mandating heightened standards for large banks offers an outline for strategic planning that smart community banks would be wise to follow.

The final rule calls for the large banks to come up with a three-year strategic plan, noting that plans covering shorter time periods would be insufficient to manage longer-term risks.  Boards must evaluate and approve strategic plans and monitor management’s implementation efforts at least annually.  [Continued on Page 2]

Under the rule, the CEO is responsible for development of the plan, with input from front line units, independent risk management and internal audit. The plan should contain:

• An overall assessment about risks the bank faces – or could face – during the life of the plan, and how those risks would affect the plan.
• A mission statement and strategic objectives, including how the bank would achieve them.
• A detailed explanation on how the bank would update its risk framework to account for changes in the bank’s risk profile projected under the strategic plan.
• The rule also notes that banks need to review and update the plan if the risk profile or operating environment changes in unanticipated ways.