What Is Economic Capital?

Economic capital is an emerging statistical concept, and it corresponds to the concept of "Regulatory Capital (RC)". Economic capital, from the inside of the bank, should be reasonably held capital.

Economic capital

economic

As an emerging capital risk management tool,

(2) Consistently grasp

Economic and regulatory capital

Economic capital is the equity capital used by commercial banks to buffer risk losses. It is the level of capital that should be owned. Regulatory capital is the level of capital required by the regulatory authority. It is the legal responsibility of commercial banks. Through the regulatory capital and its multiples, the regulatory authority is a business The maximum limit set by banks for risk assets and off-balance sheet commitments. Both economic capital and regulatory capital are used for risk buffering, but economic capital is identified and buffered internally by the managers of commercial banks, reflecting the requirements for the management of commercial banks by maximizing shareholder value; regulatory capital is sourced from the outside by the regulatory authority The identification of this buffer reflects the capital requirements of shareholders by the supervisory authority and is reflected in the capital costs of shareholders.

The use of economic capital is different from that of regulatory capital. Regulatory capital is used by the regulatory authorities to measure and control the risks of commercial banks through capital adequacy ratios. Economic capital is the internal control of risks by commercial banks through unexpected capital losses. Economic capital may also differ from regulatory capital in amount. Supervised capital is calculated according to the capital adequacy ratio regulatory caliber, and there is actually capital (equity capital is part of it) that can be used to make up for expected losses. In order to fully resist risks, the regulatory capital of banks should exceed economic capital, or economic capital should be less than regulatory capital (the most economical form is that they are equal). If the economic capital exceeds the regulatory capital, it means that the risk of unexpected losses faced by the bank exceeds the capital capacity, and the capital support for the risk is insufficient. If economic capital increases, in order to maintain the level of capital adequacy, regulatory capital should increase at least by the same amount. If economic capital increases but regulatory capital does not increase, the level of capital adequacy will decrease.

Economic capital and actual capital

The actual capital of a commercial bank is capital in the accounting sense, also known as owner's equity, and is the net value of total assets minus total liabilities. Including invested capital, capital reserve, surplus reserve and undistributed profits. Actual capital reflects the level of capital actually owned by commercial banks.

Economic capital is not actual capital, nor is it the distribution of actual capital. It is an internal virtual resource allocation method, but it should correspond to the growth of real capital. This can be understood as the total amount of capital is concentrated in the head office. The head office allocates the amount of capital used (but not the actual allocation) to each branch, and each branch allocates the amount to the risk of loss of each business (asset). Through such a virtual distribution method, the economic capital problems of branches and businesses can be made consistent with the total amount of capital supervised by the head office to ensure that assets have sufficient risk buffering.

Economic capital management

Note: Bank losses = expected losses (covered by reserves) + unexpected losses (covered by economic capital) + extreme losses (calculated through stress tests)

The critical point between the first two losses and the third loss is called VAR

English meaning:

Economic Capital