December 12: What Is “Economic Capital?” - A Quick Guide to the Differences between Economic Capital and Regulatory Capital
Location: Chicago
Author:
Date: Friday, December 12, 2003
It’s understandable that the newer term “economic capital” is doubly confusing, especially given the heroic efforts bankers have made just to understand regulatory capital requirements. The accounting view of capital is the most well-known. Its focus is the sum of certain items on the claims side of the balance sheet, such as the book value of shareholders equity, paid-in capital, and retained earnings. That perspective views capital mostly as a source of funding. Risk has no bearing on it. The regulatory view of capital refers to specific categories of equity (and other equity-like claims) used to meet capital regulations. Officially-defined “tiers” of capital attempt to reflect different liquidity characteristics and different levels of capacity to absorb losses. This article will guide you through the process of better understanding the difference in the terms.
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Source: Eric Banfield, FRM, CRP, PRM
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