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

A bank uses economic capital for several purposes. Which use below would be LEAST appropriate given the conceptual nature of economic capital as an internal risk-based measure?

Using economic capital to replace the legally binding supervisory minimum is least appropriate. Economic capital is an internal measure used for allocation, performance measurement, limits, pricing, and adequacy assessment, but regulatory minimums remain binding and cannot be substituted by internal estimates.

  1. AAllocating capital to business lines for risk-adjusted performance measurement
  2. BSetting risk-based limits and informing pricing of transactions
  3. CAssessing capital adequacy relative to the bank's own risk appetite
  4. DReplacing the supervisory minimum capital requirement as the legally binding capital floorCorrect

Explanation

Economic capital supports internal uses such as allocation, performance measurement, limits, pricing, and adequacy assessment under Pillar 2. It is an internal estimate and cannot legally replace supervisory minimum requirements, which remain binding. The other three are standard uses.

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