Credit risk and economic capital

  • What is economic capital for credit risk?

    Economic capital is a measure of risk in terms of capital.
    More specifically, it's the amount of capital that a company (usually in financial services) needs to ensure that it stays solvent given its risk profile.
    Economic capital is calculated internally by the company, sometimes using proprietary models..

  • What is market risk economic capital?

    Market risk economic capital (EC) is intended to capture the value change due to changes in market risk factors.
    It is an internal capital reserve to cover unexpected loss due to market movement..

  • What is the difference between economic capital and risk based capital?

    Economic capital primarily aims to support business decisions, while RC aims to set minimum capital requirements against all risks in a bank under a range of regulatory rules and guidance..

  • What is the difference between risk based capital and economic capital?

    Economic capital primarily aims to support business decisions, while RC aims to set minimum capital requirements against all risks in a bank under a range of regulatory rules and guidance..

  • What is the relationship between risk and capital?

    Rather, taking greater risk may result in the loss of a larger amount of capital.
    A more correct statement may be that there is a positive correlation between the amount of risk and the potential for return.
    Generally, a lower risk investment has a lower potential for profit..

  • Economic capital is the amount required which, invested at the risk-free rate, covers the potential downside in earnings.
    Such a model provides a good rule of thumb for management when determining the proper amount of capital for the bank as a whole, but will it work at the level of individual businesses?
  • Economic or financial capital entails monetary funds and investments like equity, debt, or real estate.
  • Moreover, economic capital depends on the loan rate r, the deposit rate c, and the cost of bank capital δ, whereas regulatory capital depends on the confidence level α set by the regulator.
Economic capital is a measure of risk in terms of capital. More specifically, it's the amount of capital that a company (usually in financial services) needs to ensure that it stays solvent given its risk profile. Economic capital is calculated internally by the company, sometimes using proprietary models.
The capital adequacy ratio (CAR) is defined as a measurement of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures.

What is economic capital & how is it used?

Economic capital is used by financial services companies, such as:

  • banks and insurance firms.
    It is also used for measuring and gauging the market and operational risks of a financial services company.
    Economic capital captures the inherent risk of the economic environment, as opposed to regulatory and accounting rules.
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    What is economic capital (ECAP)?

    In finance, mainly for financial services firms, economic capital (ecap) is the amount of risk capital, assessed on a realistic basis, which a firm requires to cover the risks that it is running or collecting as a going concern, such as:

  • market risk
  • credit risk
  • legal risk
  • and operational risk.
    • ,

    What is economic risk?

    Economic risk refers to the probability of default from extreme (“tail”) losses.
    Creditors and depositors require a certain level of capital to absorb losses and thus reduce the risk of default.

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    What is risk capital?

    It is the amount of money that is needed to secure survival in a worst-case scenario.
    Firms and financial services regulators should then aim to hold risk capital of an amount equal at least to economic capital.

    Amount of money needed to secure survival in a worst-case scenario

    In finance, mainly for financial services firms, economic capital (ecap) is the amount of risk capital, assessed on a realistic basis, which a firm requires to cover the risks that it is running or collecting as a going concern, such as market risk, credit risk, legal risk, and operational risk.
    It is the amount of money that is needed to secure survival in a worst-case scenario.
    Firms and financial services regulators should then aim to hold risk capital of an amount equal at least to economic capital.

    Categories

    Credit risk example
    Credit risk exposure
    Credit risk example in banks
    Credit risk evaluation
    Credit risk exit opportunities
    Credit risk exposure calculation
    Credit risk expected loss
    Credit risk engine
    Credit risk events
    Credit risk ey
    Credit and risk function
    Credit risk and forward rate agreement
    Credit risk and financial performance
    Credit risk and finance
    Credit risk and forward contract
    Credit risk and funds
    Credit spread and risk free rate
    Credit risk formula
    Credit risk factors
    Credit risk framework