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

A bank's board wants to use economic capital (EC) as an input to strategic decisions such as business-line growth targets and risk appetite limits. Which use best reflects how EC is typically applied in management and governance under the BCBS range-of-practices paper on economic capital?

Economic capital is best used to compare risk-adjusted returns across business lines and to set limits consistent with risk appetite. It supplements regulatory capital rather than replacing it, and it is not used to set accounting provisions or tax bases.

  1. AReplacing all regulatory capital requirements so that the bank no longer reports regulatory ratios
  2. BComparing risk-adjusted returns across business lines and setting risk limits consistent with the bank's risk appetiteCorrect
  3. CCalculating the accounting provisions that must be booked each quarter
  4. DDetermining the tax base for each legal entity in the group

Explanation

EC provides a common risk-based measure that lets management compare return on capital across businesses and calibrate limits to risk appetite. It supplements, not replaces, regulatory capital, and it does not drive accounting provisions or tax computation.

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