Economic Capital Analysis

We provide our clients specific tools to evaluate, plan and manage your economic capital needs. These include tools and procedures for both determining the true amount of economic capital tied up by business/financial position/product type etc. and the impact of economic capital on pricing of products and services.

Economic Capital (or Risk Capital) – Cushion against Unexpected Losses

Economic Capital is the amount of equity capital to be held to support a particular level of risky business activity. This can be interpreted e.g. in terms of Value-at-Risk, the maximum possible loss within a known confidence level over a given holding period. The amount of Economic Capital depends on time horizon and confidence level (regulator vs. lenders’ vs. owners’ view).

Economic Capital Requirement

The underlying idea in calculating economic capital is to obtain an accurate estimate of the true risk. This is very important in risk-based pricing – a bank cannot be competitive in pricing good business if it does not understand its actual risk contribution – or a bank may be attracting bad business for the same reason. Any observed and verified smoothing must be included in calculating economic capital both between and within broad risk categories.

R/V Platform and Risk Calculations

In the R/V Platform smoothing between risk categories and risk factors is treated generally by correlated path simulations. In this environment the Compliance and Economic Capital cases are simply different calculations with different correlation structures. For Compliance reporting, use regulator-specified parameters. For Economic Capital reporting use estimated, subjective( management-determined) or combined correlation values.