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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

A bank calculates stand-alone economic capital of USD 120 million for credit risk, USD 80 million for market risk and USD 50 million for operational risk. The bank's aggregated enterprise-wide economic capital, after reflecting diversification, is USD 205 million. Which conclusion is most appropriate?

The simple sum of stand-alone capital is USD 250 million, so aggregation to USD 205 million implies a USD 45 million diversification benefit. Measured against the undiversified sum, that is 18%. A total below the sum reflects imperfect correlation, not a concentration penalty.

  1. AThe diversification benefit is USD 45 million, which is 18% of the simple sum of USD 250 millionCorrect
  2. BThe diversification benefit is USD 45 million, which is 22% of the simple sum of USD 205 million
  3. CThe diversification benefit is USD 45 million, which is 18% of the aggregated capital of USD 250 million
  4. DThe aggregation shows a USD 45 million concentration penalty, since the total is below the sum

Explanation

Simple sum = 120+80+50 = 250. Diversification benefit = 250-205 = 45, and 45/250 = 18%. Option B uses the wrong base (205), and C misidentifies 250 as the aggregated figure. A lower total than the sum indicates a benefit, not a penalty.

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