Economic capital

In finance, mainly for financial services firms, economic capital is the amount of risk capital, assessed on a realistic basis, which a firm requires to cover the risks that it is running or collecting as a going concern, such as market risk, credit risk, and operational risk. It is the amount of money, which is needed to secure the survival in a worst case scenario. Firms and financial services regulators should then aim to hold risk capital of an amount equal at least to economic capital.

Typically, economic capital is calculated by determining the amount of capital that the firm needs to ensure that its realistic balance sheet stays solvent over a certain time period with a pre-specified probability. Therefore, economic capital is often calculated as value at risk.

The concept of economic capital differs from regulatory capital in the sense that regulatory capital is the mandatory capital the regulators require to be maintained while economic capital is the best estimate of required capital that financial institutions use internally to manage their own risk and to allocate the cost of maintaining regulatory capital among different units within the organization.

ee also

*Basel II
*Financial services conglomerate
*Financial risk management
*RAROC, risk-adjusted return on capital

References

cite book
last = Porteous
first = Bruce T.
coauthors = Pradip Tapadar
title = Economic Capital and Financial Risk Management for Financial Services Firms and Conglomerates
publisher = Palgrave Macmillan
date = 2005
month = December
id = ISBN 1-4039-3608-0

External links

* [http://www.fdic.gov/regulations/examinations/supervisory/insights/siwin04/economic_capital.html Economic Capital and the Assessment of Capital Adequacy] , Federal Deposit Insurance Corporation