Bank of Montreal 2015 Annual Report Download - page 59

MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
Enterprise-Wide Capital Management
BMO’s Common Equity Tier 1 Ratio of 10.7% is strong and exceeds regulatory requirements.
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:
‰is appropriate given our target regulatory capital ratios and internal assessment of required Economic Capital;
‰is consistent with our target credit ratings;
‰underpins our operating groups’ business strategies; and
‰supports depositor, investor and regulator confidence, while building long-term shareholder value.
Capital Management Framework
The principles and key elements of BMO’s capital management framework are outlined in our Capital Management Corporate Policy and in our annual
capital plan, which includes the results of our Internal Capital Adequacy Assessment Process (ICAAP).
ICAAP is an integrated process that evaluates capital adequacy on both a regulatory and an economic capital basis, and is used to establish
capital targets and capital strategies that take into consideration the strategic direction and risk appetite of the enterprise. The capital plan is
developed considering the results of our ICAAP and in conjunction with our annual business plan, promoting alignment between our business and risk
strategies, regulatory and economic capital requirements and the availability of 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 levels. 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 a combination of regulatory and economic capital to evaluate business performance and considers capital implications in its strategic,
tactical and transactional decision-making. By allocating our capital to operating groups and measuring their performance in relation to the capital
necessary to support the risks in their business, we seek to optimize 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 support the strategic growth activities of our operating groups. We increased the capital allocated to the operating groups in fiscal 2015
given higher capital expectations for the bank. Capital in excess of what is required to support our line of business activities is held in Corporate Services.
Capital adequacy
assessment of capital
demand and supply
Capital Demand Capital Supply
Management
Actions
Capital available to
support risks
Capital required to support
the risks underlying our
business activities
For further discussion of the risks underlying our business activities, refer to the Enterprise-Wide Risk Management section on page 86.
Governance
The Board of Directors, either directly or in conjunction with its Risk Review Committee, provides ultimate oversight and approval of capital
management, including our Capital Management Corporate Policy framework, capital plan and capital adequacy assessments. The Board regularly
reviews BMO’s capital position and key capital management activities, and the Risk Review Committee reviews the ICAAP-determined capital
adequacy assessment results. The Balance Sheet and Capital Management Committee provides senior management oversight, including the review
and discussion of significant capital management policies, issues and activities and, along with the Risk Management Committee, the capital required
to support the execution of our enterprise-wide strategy. Finance and Risk Management are responsible for the design and implementation of the
corporate policies and framework related to capital and risk management and the ICAAP.
Regulatory Capital
Common equity is the most permanent form of capital. Common Equity Tier 1 (CET1) capital is comprised of common shareholders’ equity less
deductions for goodwill, intangible assets, defined benefit pension assets, certain deferred tax assets and certain other items. Additional Tier 1 capital
primarily consists of preferred shares and innovative hybrid instruments, less certain regulatory deductions. Tier 1 capital is comprised of CET1 capital
and Additional Tier 1 capital. Tier 2 capital is primarily comprised of subordinated debentures and a portion of the collective and individual allowances
for credit losses, less certain regulatory deductions. Total capital includes Tier 1 and Tier 2 capital.
Regulatory capital requirements for BMO are determined on a Basel III basis. The minimum Basel III capital ratios proposed by the Basel
Committee on Banking Supervision (BCBS) were a 4.5% CET1 Ratio, 6% Tier 1 Capital Ratio and 8% Total Capital Ratio. These ratios are calculated
using a five-year transitional phase-in of regulatory adjustments and a nine-year transitional phase-out of non-qualifying capital instruments.
However, guidance issued by the Office of the Superintendent of Financial Institutions Canada (OSFI) required Canadian deposit-taking institutions to
meet the 2019 Basel III capital requirements in 2013, other than the phase-out of non-qualifying capital instruments, and OSFI has expected banks to
70 BMO Financial Group 198th Annual Report 2015