FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks
A bank's risk committee is reviewing how its economic capital measure differs from regulatory capital. Which statement best describes economic capital as discussed in the BCBS range-of-practices paper?
Economic capital is the bank's own estimate of the capital needed to absorb unexpected losses at a chosen confidence level and horizon, reflecting its specific risk profile. It differs from uniform regulatory minimums, book equity, and expected losses, which are covered by pricing and provisions.
- AAn internally estimated amount of capital needed to cover unexpected losses at a chosen confidence level over a set horizon, tied to the bank's own risk profileCorrect
- BA minimum capital ratio set by supervisors that applies uniformly to all banks regardless of their internal risk estimates
- CThe accounting book value of shareholders' equity reported on the balance sheet
- DThe amount of capital needed to cover expected losses on the loan portfolio over one year
Explanation
Economic capital is the bank's internal estimate of capital needed to absorb unexpected losses at a target confidence level and horizon, reflecting its own risk profile. Regulatory capital is a supervisory minimum, and expected losses are normally covered by pricing and provisions rather than capital.
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