Finance Junkie
Posts: 205
Joined: Mon Feb 04, 2013 3:35 pm


Postby » Thu Oct 02, 2014 7:42 am

Which of the following statements does NOT adequately describe economic capital?
I. It is always less than regulatory capital.
II. It differs depending on the type of borrower, independent of borrower risk.
III. It must be considered along with regulatory capital when making allocation decisions.
IV. It is the amount of capital that management determines to be necessary to cushion losses from an asset
or business line.
A) II only.
B) I and III.
C) I and II.
D) IV only.
Your answer: B was incorrect. The correct answer was C) I and II.
Economic capital is a risk-based capital amount that is deemed necessary to cushion losses. Regulatory capital
is based on loan value (not risk), so for high-risk loans, economic capital may exceed regulatory capital.
Regulatory capital differs depending upon the type of borrower, independent of borrower risk.

My question is weather Economic capital will not change then

Finance Junkie
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Joined: Wed Apr 09, 2014 6:28 am


Postby edupristine » Mon Oct 06, 2014 4:17 am

The correct answer indeed is option C (I & II).
Statement I is incorrect because of the keyword "always". It is not a hard and fast rule that Economic capital will always be less than regulatory capital.
Statement II is also incorrect because risk of the borrower is always taken into account while calculation of economic capital. So, if there are two corporate borrowers then more economic capital will be allocated for riskier borrower and relatively less economic capital for the other less risky borrower.
While in case of calculating regulatory capital, only the type of borrowers are concerned independent of the risk they carry.

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