CASE STUDY: First National Bank of the Caribbean (FNBC) First National Bank of the Caribbean (FNBC) maintained its capital ratios according to the Basel Agreement standards in the past. That is, it never had fallen below the minimum total risk based capital ratio of 8%, the Tier 1 Risk adjusted ratio of 4% or the leverage ratio (or tier 1 to total assets) of 3%. However in recent years the banks capital ratios decreased to the point where its capital position was marginal or near the borderline. John Mason was a bank examiner reporting to the Central Bank in the Caribbean Area. He had received news that the FNBC is coming up for review next month. In preparation for the upcoming onsite visit, he had gone over a chart of FNBCS capital ratios and was concerned about their trends; similar banks did not exhibit the same downward trends; indeed strong economic growth in the region has contributed to strengthening capital ratios at some FNBCS competitors. He decided to call the CEO to discuss the timing of the review and express some preliminary concerns about FNBCs capital adequacy. The CEOs attitude was positive and a copy of the managements strategic plan was emailed to James to help him better understand the banks goals, objectives, and business conditions. John brought the plan home with him that evening to begin reviewing the situation. His first reaction to seeing the concise and well organized five-page strategic plan was one of relief. Effective strategic plans enable management to be proactive rather than reactive in responding to market forces. Such plans are long-term in nature and integrate a variety of management areas, including asset deployment, funding sources, capital formation, management, marketing, Operations, and information systems. They serve not only to provide management direction and leadership but to communicate bank goals and objectives throughout the organization.

In the capital section of the plan, James noted the following key areas and related discussion:

Growth: The bank sought to keep pace with the regions strong economic growth by rapidly expanding the loan portfolio. Many new credit opportunities were opening up due to the banks ability to offer a wider menu of financial services to customers. There was some evidence that loan concentrations had increased, especially with respect to certain local industries that had been particularly successful and, subsequently, had increased their credit lines with the bank. Bank management had become more risk tolerant in light period of good economic times.

Dividends: The bank is a subsidiary of another banking company and was dedicated to paying substantial it dividends to fund that other companys expansion goals. The banking company was attempting to expand beyond its traditional home base into adjacent territories.

Access to additional capital: since the bank was relatively small, it access to capital markets was limited. However, this limitation was not considered to be restrictive due to the fact that the other banking company could be relied upon to assist them with capital funds. The bank indicated that it was sensitive to current shareholders desire to avoid the diluting effect of new capital. Under Central bank rules a bank holding company is expected to be a source of strength to it subsidiary in terms of capital or liquidity

Earnings: Net interest margins (NIMs) had been exceptionally high from an historical standpoint. The NIM had been favourably affected by low interest rates and strong loan demand that allowed them to broaden their spread over interest cost. Nonetheless, the NIM and the rate of return on assets (ROA) had fluctuated more than in competitor banks over the last five years. The bank had recently purchased interest only strips (IOs) and principal only strips (POs), that has more price risks than other assets in order to better hedge the interest rate risk on the balance sheet. Also, in an effort to address ROA volatility, the bank had strengthened its current collateral and guarantees to upgrade the credit quality of its loan portfolio. Finally the bank had increased its provision for loan losses in the last two years.

Bank Share Prices: The Banks share price relative to book value was below its competitor banks by about 25%. Management made it clear that it believed the share price was undervalued, as opposed to low - valued due to a lack of investor confidence.

Fixed Bank Assets: The bank has a central location for its main office plus three, local branch offices. All facilities were refurbished in recent years by the holding company and electronic payments services installed to ensure that the bank could offer full array of banking, securities and insurances services.

Required: Given the preliminary information, step into Johns role and write a report in 1000 -1200 words for the staff prior to their visit to the bank. The report should cover each of the above strategic plan areas and provide an evaluation of the capital strengths and weaknesses implied in the plan. Most importantly, it should set the stage for their overall assessment of FNBCs capital adequacy.