Strategic Equity Planning: Finding the Ideal Capital Position

Dr. Harold M. Sollenberger, Michigan State University
June 23, 2005

Every credit union has an “ideal” capital position. But, finding it has been an age-old dilemma. Who should decide which risks have what needs for capital protection? This is a strategic issue that requires high-level attention, particularly in today’s highly competitive environment. The cost of both too much and too little capital is high – directly impacting a credit union’s competitive position and its financial success.

In most credit unions, capital is a residual of earnings, growth, liquidity, and asset quality decisions tied to their asset/liability policies. Capital planning should be added to the strategic planning process. Strategies to achieve ideal capital goals have direct impacts on management plans, decisions, and actions.

A process is developed to bring together executive and board member views, knowledge, experience, and opinions to assess the total array of risks facing a credit union. From this intense and collaborative evaluation, an ideal equity percentage range is developed. Changes in competition, the economic environment, and other strategic issues will affect the need for capital now and in the future. Risks are evaluated relative to the protection needed.

Among major observations from the study include the following:

• An ideal equity position results from considering all risks facing a credit union – a true risk-based and risk-weighted equity assessment.
• To arrive at a consensus, a risk-based assessment process must involve the executive team and board members, using their knowledge, experience, and judgment.
• Financial and non-financial risks are evaluated using historical, present, and forecast information from our credit union and a set of high-performing peer credit unions.
• This consensus equity position should be the basis for strategies to bring the current actual equity level into alignment with the ideal position.

A credit union’s strategic goal for finding its “ideal” capital will be achieved only if management takes action to work toward that goal, irrespective of any regulatory pressure. An ideal capital goal is a vital element in a credit union’s becoming, and continuing as, a high-performing credit union.

This executive summary is from the January 2005 CFO white paper by Harold M. Sollenberger entitled” Strategic Equity Planning: Finding the Ideal Capital Position.” For the complete white paper, visit http://www.cunacfocouncil.org/tools/research.html.