New Issues Chief Financial Officers Face in a Changing Environment
LaVine, Kenneth N., Jr., American Banker
I am pleased to be here to discuss the subject of capital from the chief financial officer's perspective. In most banks, the CFO is the primary interface with the regulatory bodies, as well as with the shareholders, through investor relations activities with security analysts and portfolio managers. Usually the CFO also acts as financial spokesman and, perhaps most importantly, provides data and analysis to the board of directors on the performance of the bank and the adequacy of its capital position. Frequently, the CFO, acting on behalf of the chief executive officer, has the task of satisfying both the regulators and the shareholders and, in so doing, managing the potential and real conflicts that arise between thee constituencies.
Thus, the CFO is at the center of the debate among the interested parties as to the importance of capital in ensuring the soundness of a bank or of the financial system in general.
Objectives of Investors and Regulators
What are the objectives of investors and regulators?
The investor looks for an adequate return on his investment. This return is a function of earnings per share growth, which usually leads to higher dividends and a higher market price. Depending on a number of quantitiative and qualitative factors, the investor assigns a P/E multiple to the earnings per share. This multiple is a reflection of the markets' assesment of the quality of earnings, the sustainability of earnings over time, the strength of the balance sheet, the adequacy of capital to generate the desires return, and the potential for dilution.
The regulators, on the other hand, seek to protect the small depositor, which really means protecting the fund that insures these depositors. They also have the charter to insure that each finnancial institution is in sound condition. Overall, tehy have the responsibility to help maintain the health of the financial system.
Where might these objectives be in conflict?
The shareholders, in looking at capital, have to be concerned about the potential for dilution and therefore the reduced value of their investments. In addition, regulatory constraints on the ability of banks to expand or diversify cause concerns to investors about growth expectations, earnings potential, and the ultimate attractivenes of the stock as a long-term investment.
At the end of the day, the primary soruce of capital for protection and growth is the equity investor. If this investor views his capital infusion as simply to be used to boost up ratios with no return potential, he just won't invest. Without investment, banks will take a back seat in the era of financial deregulation to nonbanks such as Sears, General Motors, American Express, and others who don't have the same constraints.
While the potential for conflict has existed for years, the scales have been basically in balance. The concern now is whether the emphasis given by regulators to increased capital has tipped the scales against the investor with the adverse implication I have just cited.
While the regulatory approach to capital has been beneficial in many respects, I believe the scales are beginning to swing in the wrong direction and that steps need to be taken soon to redress the imbalance. Against this backdrop, I'll make four specific points which I'll first summarize and then briefly elaborate on.
* In the first half of this decade, there is no question that more capital was required to support the activities of the banking industry. Given the recent buildup of equity and reserves and other forms of capital over the past five years, the industry as a whole is now reasonably well capitalized.
* I am becoming increasingly concerned with the current approach the regulators are following regarding capital, including the timing, pace, and degree of emphasis given to the whole subject, particularly with respect to the implementation of guidelines. …