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

Two banks both state a one-year horizon but choose different targets. Bank X calibrates economic capital at 99.90% and Bank Y at 99.97%, with identical portfolios and models. A risk manager compares their results. Which conclusion is most appropriate?

Bank Y will report higher economic capital because 99.97% lies further in the tail than 99.90%, reflecting a more conservative solvency target. Figures from different confidence levels are not directly comparable unless they are aligned or rescaled.

  1. ABank Y will report higher economic capital, reflecting a more conservative solvency target, so figures are not comparable without aligning confidence levelsCorrect
  2. BBank X will report higher economic capital because a lower confidence level implies a larger loss
  3. CBoth will report the same figure because the portfolios are identical
  4. DBank Y holds less capital because a higher confidence level means lower tail risk

Explanation

A higher confidence level moves further into the loss distribution's tail, giving a larger percentile loss and so more capital. With identical portfolios, the difference reflects only the target solvency standard, so comparisons need aligned confidence levels. Choosing the same figure ignores the calibration.

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