Bank of Montreal 2010 Annual Report Download - page 61

MD&A
Objective
BMO is committed to a disciplined approach to capital management
that balances the interests and requirements of shareholders, regulators,
depositors and rating agencies. Our objective is to maintain a strong
capital position in a cost-effective structure that:
• meets our target regulatory capital ratios and internal assessment
of required economic capital;
• is consistent with our targeted credit ratings;
• underpins our operating groups’ business strategies; and
• builds depositor confidence and long-term shareholder value.
Capital Management Framework
The principles and key elements of BMO’s capital management frame-
work are outlined in our capital management corporate policy and
in our annual capital plan, which includes the results of the Internal
Capital Adequacy Assessment Process (ICAAP).
ICAAP is an integrated process that evaluates capital adequacy, and
is used to establish capital targets and capital strategies that take into
consideration the strategic direction and risk appetite of the organization.
The ICAAP and capital plan are developed in conjunction with BMO’s
annual business plan, promoting alignment between our business and
risk strategies, regulatory and economic capital requirements, and
capital availability. Capital adequacy is assessed by comparing capital
supply (the amount of capital available to support losses) to capital
demand (the capital required to support the risks underlying our business
activities as measured by economic capital). Enterprise-wide stress
testing and scenario analysis are also used to assess the impact of
various stress conditions on BMO’s risk profile and capital requirements.
The framework seeks to ensure that we are adequately capitalized,
given the risks we take, and supports the determination of limits, goals
and performance measures that are used to manage balance sheet
positions, risk levels and capital requirements at both the consolidated
entity and line of business level. Assessments of actual and forecast
capital adequacy are compared to the capital plan throughout the year,
and the capital plan is updated as required, based on changes in our
business activities, risk profile or operating environment.
BMO uses both regulatory and economic capital to evaluate business
performance and as the basis for strategic, tactical and transactional
decision-making. By allocating capital to operating units and measuring
their performance in relation to the capital necessary to support the
risks in their business, we seek to maximize our risk-adjusted return to
shareholders, while maintaining a well-capitalized position. This approach
aims to protect our stakeholders from the risks inherent in our various
businesses, while still allowing the flexibility to deploy resources to the
high-return, strategic growth activities of our operating groups. Capital in
excess of what is necessary to support our line of business activities is
held in Corporate Services.
Governance
The Board of Directors and its Risk Review Committee provide ultimate
oversight and approval of capital management, including our capital
management corporate policy, capital plan and ICAAP results. They regu-
larly review BMO’s capital position, capital adequacy assessments and
key capital management activities. The Risk Manage ment Committee and
Capital Management Committee provide senior management oversight,
and also review and discuss significant capital policies, issues and action
items that arise in the execution of our enterprise-wide strategy. Finance
and Risk Management are responsible for the design and implementa-
tion of the corporate policies and framework related to capital and risk
management and the ICAAP. Our ICAAP operating processes are reviewed
on an annual basis by our Corporate Audit division.
2010 Regulatory Capital Review
Regulatory capital requirements for the consolidated entity are currently
determined on a Basel II basis. BMO uses the Advanced Internal Ratings
Based (AIRB) Approach to determine credit risk-weighted assets (RWA)
in our portfolio and the Standardized Approach to determine operational
RWA. In 2010, BMO’s U.S. retail banking subsidiary Harris Bancorp, Inc.
used the Standardized Approach to determine credit RWA. BMO’s market
RWA are primarily determined using the Internal Models Approach, but
the Standardized Approach is used for some exposures.
The AIRB Approach is the most advanced of the approaches for
determining credit risk capital requirements under Basel II. It utilizes
sophisticated techniques to measure RWA at the borrower level, based on
sound risk management principles, including consideration of estimates
of the probability of default, the likely loss given default, exposure
at default, term to maturity and the type of Basel Asset Class exposure.
These risk parameters are determined using historical portfolio data
supplemented by benchmarking, and are updated periodically. Validation
procedures related to these parameters are in place and are enhanced
periodically in order to appropriately quantify and differentiate risks so
they reflect changes in economic and credit conditions.
Under the Standardized Approach, operational risk capital require-
ments are determined by the size and type of our lines of business.
Gross income, as defined under Basel II, serves as a proxy for the size of
the line of business and as an indicator of operational risk. Gross income
is segmented into eight regulatory business lines by business type, and
each segment amount is multiplied by a corresponding factor prescribed
by the Basel II framework to determine its operational risk capital
requirement. For further details on Basel II, refer to the Enterprise-Wide
Risk Management section starting on page 75.
Enterprise-Wide Capital Management
For further discussion of the risks that underlie our business activities, refer to the Enterprise-Wide
Risk Management section on page 75.
Capital Demand
Capital required
to support the
risks underlying
our business
activities as
measured by
economic capital
Capital Supply
Capital available
to support losses
Management
Actions
Capital adequacy
assessment of capital
demand and supply
BMO Financial Group 193rd Annual Report 2010 59