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FRM Part II · FRM Exam Part II · Capital Structure in Banks

A bank's CFO notes that economic capital is computed at 99.95% confidence while a peer uses 99.90% for the same portfolio. Holding all else equal, which conclusion is most appropriate?

The bank's economic capital will be higher. A 99.95% confidence level reaches further into the loss tail than 99.90%, so the loss quantile and the unexpected loss buffer are larger. This reflects a more conservative solvency target, while expected loss is unchanged.

  1. AThe bank's economic capital will be lower than the peer's, because higher confidence means fewer losses
  2. BThe two figures are directly comparable because confidence level only affects regulatory capital
  3. CThe bank's economic capital will be higher than the peer's, reflecting a more conservative solvency targetCorrect
  4. DThe bank's expected loss will be higher than the peer's

Explanation

Economic capital is the loss quantile minus expected loss; a higher confidence level moves further into the tail, increasing the required capital. Expected loss does not depend on confidence level, and the confidence level directly drives internal economic capital.

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