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

A bank's one-year credit loss distribution has an expected loss of 120 million, and the 99.9th percentile loss is 870 million. Using the common convention that economic capital covers unexpected loss, what is the economic capital for credit risk at the 99.9% confidence level?

Economic capital is 750 million. It equals the 99.9th percentile loss of 870 million minus the expected loss of 120 million, because expected losses are covered by pricing and provisions and capital is held against unexpected losses.

  1. A990 million
  2. B870 million
  3. C120 million
  4. D750 millionCorrect

Explanation

Economic capital = percentile loss minus expected loss = 870 - 120 = 750 million. 870 ignores that expected loss is covered by pricing and provisions. 990 adds instead of subtracts (wrong sign). 120 is only expected loss.

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