Economic Capital

Risk Aggregation & Consolidation

Economic capital is the financial buffer that financial institutions must hold based on the Basel Accord. It protects against potential losses from credit, market, and operational risks, calculated by considering the probability and magnitude of these risks. It represents a portion of a firm's risk capital and helps assess the level of risk the firm faces. Adequate provisions are essential to ensure the firm can continue operating. Every financial institution should have economic capital as part of its internal considerations to withstand unexpected losses and maintain operations beyond regulatory requirements.

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Derivation of Economic Capital

In modelling terms or graphical presentation, as the gap between Expected Loss and internally defined Confidence Level. This is the very approach relevant for managing entity.

Strategic Business Plan

The phrase 'risk vs return' is loved by analysts to justify economic capital derivations and conclusions reached to justify investment and associated risk to stakeholders.

AS Performance Measure

Performance measures that use economic capital include: return on risk-adjusted capital (RORAC); risk-adjusted return on capital (RAROC); and, economic value added (EVA)

Economic Capital - Application

Economic Capital (EC) is a model-based assessment of future risk for an entity. It differs from Regulatory Capital (RC) mandated by regulators and Finance Capital based on accounting principles. EC ensures sufficient financial resources to cover potential losses, aligning with Basel Accord Standards for regulatory compliance. It aids in identifying, measuring, and managing risks while ensuring overall financial health and regulatory monitoring.

Regulatory Business Strategy

Regulatory Business Plan (RBP) stipulates policies, procedures and implementation approach that a regulator approves after if it meets minimum expected requirements espercially regarding risk and compliance.

Portfolio Management

Individual transactions are grouped by classification to form portfolios for ease of management. Internal risk weights are assigned and applied to portfolios based on perception of anticipated associated risk.

ICAAP & ILAAP & ICARA Models

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ICAAP, ILAAP, & ICARA are internal risk management models for assessing capital adequacy; and are used with Supervisory Review and Evaluation Process (SREP) tools by regulators to assess internal models.