When determining your optimal net-worth ratio, aim for the “roughly right” amount, says Adam Johnson, CEO/principal at c. myers corp.
“There’s no one right amount for everyone,” says Johnson, who addressed the CUNA Finance Council Virtual Conference Collection.
Achieving the right capital level is becoming “a bigger balancing act” between the need to build or conserve net worth versus using capital to deploy initiatives that may lead to long-term growth, he says.
Many credit unions struggle to grow capital due to increased deposits, lower earnings, greater demands for capital, and the need to meet rising consumer expectations and operate in a highly competitive environment, Johnson says.
While there are consequences for being either too conservative or too aggressive, “institutions that have a structured process to identify the amount of capital they need based on their unique business model, strategic direction, and risk tolerance are better positioned to make good decisions about their use of capital,” he says. “Setting capital targets is a strategic decision credit unions should approach with the same rigor as other strategic decisions.”
This process entails determining what you’ll have to give up or slow down to achieve a certain level of capital and identifying the opportunity trade-offs, Johnson says.
It also involves using a blend of instinct, math, and analysis to build a process for achieving desired capital levels.
Consider these questions:
The wrong way to determine the right capital level? Applying pure probability to your risk factors, Johnson says. “When you’re dealing with risks, you’re usually dealing with some unlikely events.”
He offers four key takeaways:
“The ‘why’ is more important than the actual number,” Johnson says. “Understand what’s driving you.”