FRM Exam Part II · Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice

Capital Impact Assessment and Capital Policy for Bank Holding Companies

Updated 11 October 2026 · Fact-checked

Capital impact assessment turns projected losses, revenue and balance sheet changes into regulatory capital ratios over the planning horizon. Capital policy then sets internal goals, triggers and contingency actions, such as cutting dividends or buybacks. To solve questions, project capital, divide by risk-weighted assets, compare with goals and triggers, then choose the action.

Understand Capital Impact Assessment and Capital Policy

A large bank holding company (BHC) does not just ask whether it has enough capital today. It asks whether it will still have enough after a severe but plausible stress. Capital impact assessment is the step that answers this. It takes the projected losses, revenue, expenses and balance sheet from the stress models and turns them into capital ratios, quarter by quarter.

The logic is simple. Start with opening capital. Add projected net income (pre-provision net revenue less provisions and other losses). Subtract planned distributions such as dividends and share repurchases. Adjust for regulatory deductions and other items. This gives ending capital. Risk-weighted assets (RWA) are also projected, because a stress can raise RWA as assets are downgraded or drawn exposures grow. The ratio is capital ÷ RWA.

A good assessment uses the regulatory definitions, such as common equity Tier 1 (CET1) and total capital, and also the leverage ratio. It must reflect the rules as they apply over the horizon, including phase-ins. The supervisory expectation is that the process is clear, repeatable and tied to the stress results, with the assumptions documented and challenged.

Capital policy is the board-approved framework that sits on top. It sets capital goals, which are internal target levels above the regulatory minimums and buffers. It sets triggers, which are defined levels or events that force management to act. It also sets contingency actions, the ordered list of steps if capital falls toward a trigger: reducing or suspending share buybacks, cutting dividends, slowing asset growth, selling assets, raising new capital.

In practice, flexible and quickly reversible actions come first. Buybacks are usually cut before dividends because dividends are sticky and cutting them signals distress. Supervisors expect that the actions are credible, sized to the shortfall, and realistic in stress when markets may be closed. A plan that relies on raising equity in the worst quarter is weak.

Key formulas to remember

Capital ratio: Capital ratio = Regulatory capital ÷ Risk-weighted assets; Use the matching capital measure in the numerator (CET1, Tier 1 or total capital) for each ratio.
Ending capital roll-forward: Ending capital = Opening capital + Net income − Dividends − Buybacks ± Other adjustments; Net income in stress includes projected losses and provisions, so it can be negative.
Leverage ratio: Tier 1 leverage ratio = Tier 1 capital ÷ Average total assets (or leverage exposure under the relevant rule); Check which denominator the question uses. It does not use risk weights.
Capital buffer over goal: Excess (shortfall) = Projected ratio − Capital goal or trigger; Positive means room to distribute. Negative means contingency actions are needed.
Capital needed to meet a target: Capital needed = Target ratio × RWA − Projected capital; A positive result is the amount to preserve or raise, for example by cutting distributions.

How to solve Capital Impact Assessment and Capital Policy questions

Use this order for any capital impact or capital policy question. It keeps numerator, denominator and policy action separate.

1Identify the capital measure asked for (CET1, Tier 1, total capital or leverage) and the scenario or horizon.
2Roll capital forward: opening capital plus net income (or minus loss), minus planned dividends and buybacks, plus or minus other adjustments.
3Project the denominator: use stressed RWA, or average assets for the leverage ratio.
4Compute the ratio and note the lowest point over the horizon, not just the end.
5Compare it with the regulatory minimum plus buffers, then the internal capital goal and the trigger.
6If it breaches, work out the capital gap using target ratio × RWA minus projected capital.
7Pick contingency actions in a sensible order and check they are credible in stress: cut buybacks first, then dividends, then growth, then raise capital.
8State the interpretation: whether planned distributions are supportable and what management and the board must do.

Quickest way: Ratio, gap, action

When to use it: Use this for numeric MCQs with a capital roll-forward and a trigger or goal.

Write ending capital in one line from the given figures.
Divide by the stressed RWA.
Compare with the goal or trigger and pick the nearest answer.
For gap questions, compute target × RWA − capital.
For action questions, choose the most flexible, reversible step first, usually the buyback.

Common mistakes in Capital Impact Assessment and Capital Policy

Using start-of-period or unstressed RWA in the denominator.
Students focus on losses and forget RWA can rise in stress.
Fix: Always check whether the question gives stressed RWA and use it.
Forgetting to subtract planned dividends and buybacks from capital.
Net income looks like the only flow that matters.
Fix: Use the full roll-forward: opening + net income − distributions ± adjustments.
Mixing capital measures, such as dividing Tier 1 capital by total-capital requirements.
Several ratios and thresholds appear together.
Fix: Match the numerator to the ratio named before dividing.
Treating a capital goal as the regulatory minimum.
Both are shown as target levels.
Fix: Remember goals are internal and set above minimums plus buffers. Triggers are the levels that force action.
Choosing to cut dividends before buybacks.
Both return cash to shareholders, so they look equal.
Fix: Buybacks are discretionary and easy to stop. Dividends are sticky, so they are cut later.
Accepting a contingency plan that depends on raising equity in stress.
Raising capital looks like a clean fix on paper.
Fix: Judge credibility. Supervisors want actions that work when markets are stressed.

Worked examples

Example 1

A BHC starts the horizon with CET1 capital of $60 billion. Stressed net income over the horizon is −$8 billion. It plans dividends of $4 billion and buybacks of $3 billion. Other adjustments are zero. Stressed RWA is $600 billion. Its internal CET1 goal is 9%. What is the projected CET1 ratio, and is the goal met?

Show the solution

Ending CET1 = 60 − 8 − 4 − 3 = $45 billion.
CET1 ratio = 45 ÷ 600 = 7.5%.
Compare with the goal: 7.5% is below 9%, a shortfall of 1.5 percentage points.
Capital needed for the goal = 9% × 600 − 45 = 54 − 45 = $9 billion.

Answer: The projected CET1 ratio is 7.5%, below the 9% goal. The shortfall is $9 billion, so the plan needs action.

Example 2

Using the previous facts, management suspends the $3 billion buyback and cuts the dividend from $4 billion to $1 billion. What is the new CET1 ratio, and does it meet the 9% goal?

Show the solution

New distributions = 1 + 0 = $1 billion.
Ending CET1 = 60 − 8 − 1 = $51 billion.
CET1 ratio = 51 ÷ 600 = 8.5%.
Compare with 9%: still 0.5 percentage points short. Capital needed = 54 − 51 = $3 billion.

Answer: The CET1 ratio rises to 8.5%, still below the 9% goal by $3 billion. Further action is needed, such as stopping the dividend, slowing RWA growth or raising capital.

Exam tips

Read which ratio is asked and check the numerator and denominator match it.
In numeric questions, subtract both dividends and buybacks. Many wrong options leave one out.
Remember the order of actions: buybacks first, dividends later, capital raising last.
For interpretation questions, link the answer to credibility under stress and to board-approved triggers.
Watch for the lowest ratio during the horizon. The minimum point can matter more than the ending value.

Practice questions from Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice

Capital Impact Assessment and Capital Policy: frequently asked questions

How do stress losses affect regulatory capital ratios?

Losses and higher provisions reduce net income, which cuts capital in the numerator. Stress can also raise RWA in the denominator. Both effects push ratios down.

What is a capital contingency plan trigger?

A trigger is a predefined capital level or event that requires management to act. It links to specific actions, such as cutting buybacks or dividends, and is approved by the board.

What is the difference between a capital goal and a regulatory minimum?

The regulatory minimum is set by regulators. A capital goal is an internal target set above the minimum and any buffers, to give the bank room to absorb stress.

Why do banks cut buybacks before dividends?

Buybacks are discretionary and can be stopped quickly with little signalling cost. Dividends are expected by investors, so cutting them signals weakness and is done later.