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

A bank's chief risk officer notes that economic capital for market risk is calibrated at 99.9% over a one-year horizon, while the regulatory trading book measure uses a shorter horizon. What is the main reason banks often choose a one-year horizon for economic capital?

Banks commonly use a one-year horizon because it approximates the time needed to raise fresh capital or take corrective action, and it fits budgeting and planning cycles. It does not ensure normality, remove correlation modeling, or make economic capital equal regulatory capital.

  1. AIt matches the horizon over which a bank could realistically raise new capital or take corrective action, and aligns with planning cyclesCorrect
  2. BIt guarantees losses are normally distributed
  3. CIt removes the need to model correlations between risk types
  4. DIt ensures economic capital always equals regulatory capital

Explanation

A one-year horizon reflects the time needed to raise capital or restructure, and aligns with budgeting and planning. It does not make losses normal, remove correlation modeling, or equate economic and regulatory capital.

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