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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A bank compares its economic capital with regulatory capital. Which statement is most accurate regarding the typical differences between the two?

Economic capital is the bank's own estimate of the capital required to absorb unexpected losses at a chosen confidence level, often linked to a target credit rating, and can reflect bank-specific diversification. Regulatory capital, by contrast, is determined by supervisory rules and standardized or approved approaches.

  1. AEconomic capital is set by supervisors using standardized risk weights, whereas regulatory capital is internally modeled
  2. BEconomic capital is an internal estimate of capital needed to absorb unexpected losses at a chosen solvency confidence level and can reflect bank-specific diversificationCorrect
  3. CEconomic capital must always exceed regulatory capital for every risk type
  4. DEconomic capital excludes operational and business risk, while regulatory capital includes all risks

Explanation

Economic capital is internally estimated for a target confidence level tied to the bank's desired credit rating, and can recognize firm-specific risks and diversification. Regulatory capital follows supervisory rules. The reversed description and the claims that it is always larger or excludes operational risk are wrong.

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