Capital Efficiency and Optimization

Insights

Capital efficiency and optimization

Measured steps to achieve return on equity objectives

Highlighting the manner in which banks can seek to unlock and enhance capital efficiency through simple improvements. While long-term sustained investments are important for enhancing return on equity, smaller corrections and enhancements can create a sound base for unlocking existing capital.

As regulators seek to strengthen the stability and solvency of financial institutions, the pressure on return on equity is immense. Regulators have been prodding banks to align themselves with the BASEL III requirements and the phase-in period for BASEL III requirements has commenced. These requirements strain the return on equity on two fronts:

  • The core equity and Tier II capital requirements are expected to increase due to the non-qualification of certain instruments for consideration as eligible capital, control on leverage ratio and increase in the base capital requirements.
  • The need to hold relatively low-yielding highquality stock of liquid assets is expected to reduce profitability as fund deployment is not always made to the highest yielding asset.

These requirements create fundamental growth challenges for banks, especially those seeking to increase their asset base. These requirements, while aimed at promoting sustainable growth for banks, can lead to near-term slowdown as the impact is assessed and translated relatively slowly into the product pricing mechanism.

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