FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks
A bank uses economic capital for both internal decision-making and for communicating with rating agencies. A new business head argues that because regulatory capital requirements are already met, the economic capital framework adds no value. Which response best reflects a purpose of economic capital highlighted in the range-of-practices work?
Economic capital complements regulatory requirements by measuring capital adequacy against the bank's own risk profile, including concentrations and risks poorly captured by regulation. It also supports performance measurement, capital allocation and limits. It does not replace regulatory minimums or guarantee compliance.
- AEconomic capital replaces regulatory capital and so removes the need for supervisory minimums
- BEconomic capital lets the bank assess capital adequacy against its own risk profile, including risks poorly captured by regulatory rules, and supports risk-adjusted performance measurement and limit settingCorrect
- CEconomic capital guarantees that the bank will never fall below regulatory minimums
- DEconomic capital is relevant only for pricing expected losses on loans
Explanation
Economic capital complements regulatory capital: it reflects the bank's actual risk profile (concentrations, diversification, risks not covered in Pillar 1), and feeds capital adequacy assessment, RAROC and allocation. It does not replace regulatory capital, give guarantees, or deal with expected loss pricing.
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