Economic capital

Finance and Economics

In financial services
Financial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...

 firms, economic capital can be thought of as the capital level shareholders would choose in absence of capital regulation.

More specifically, it 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
Going concern
A going concern is a business that functions without the threat of liquidation for the foreseeable future, usually regarded as at least within 12 months.-Definition of the 'going concern' concept:...

, such as market risk
Market risk
Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices...

, credit risk
Credit risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....

, and operational risk
Operational risk
An operational risk is, as the name suggests, a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates...

. Firms and financial services regulators should then aim to hold risk capital of an amount equal at least to economic capital.

Typically, economic capital is calculated by determining the amount of capital that the firm needs to ensure that its realistic balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...

 stays solvent over a certain time period with a pre-specified probability. Therefore, economic capital is often calculated as value at risk
Value at risk
In financial mathematics and financial risk management, Value at Risk is a widely used risk measure of the risk of loss on a specific portfolio of financial assets...

. The balance sheet, in this case, would be prepared showing market value (rather than book value) of assets and liabilities.

The first accounts of economic capital date back to the ancient Phoenicians, who took rudimentary tallies of frequency and severity of illnesses among rural farmers to gain an intuition of expected losses in productivity. These calculations were advanced by correlations to predictions of climate change, political outbreak, and birth rate change.

The concept of economic capital differs from regulatory capital in the sense that regulatory capital is the mandatory capital the regulators require to be maintained while economic capital is the best estimate of required capital that financial institutions use internally to manage their own risk and to allocate the cost of maintaining regulatory capital among different units within the organization.

Social science

In social science, economic capital is distinguished in relation to other types of capital which may not necessarily reflect a monetary or exchange-value. These forms of capital include cultural capital
Cultural capital
The term cultural capital refers to non-financial social assets; they may be educational or intellectual, which might promote social mobility beyond economic means....

 and social capital
Social capital
Social capital is a sociological concept, which refers to connections within and between social networks. The concept of social capital highlights the value of social relations and the role of cooperation and confidence to get collective or economic results. The term social capital is frequently...

, and they represent a type of power or status that an individual can attain in capitalist society
A society, or a human society, is a group of people related to each other through persistent relations, or a large social grouping sharing the same geographical or virtual territory, subject to the same political authority and dominant cultural expectations...

 via a formal education or through social ties. Non-economic forms of capital have been variously discussed most famously by sociologist Pierre Bourdieu
Pierre Bourdieu
Pierre Bourdieu was a French sociologist, anthropologist, and philosopher.Starting from the role of economic capital for social positioning, Bourdieu pioneered investigative frameworks and terminologies such as cultural, social, and symbolic capital, and the concepts of habitus, field or location,...


Economic capital might also be understood in the social sciences and social theory
Social theory
Social theories are theoretical frameworks which are used to study and interpret social phenomena within a particular school of thought. An essential tool used by social scientists, theories relate to historical debates over the most valid and reliable methodologies , as well as the primacy of...

 as the purely monetary type of capital often associated to the ruling classes of capitalist society, in particular the bourgeoisie
In sociology and political science, bourgeoisie describes a range of groups across history. In the Western world, between the late 18th century and the present day, the bourgeoisie is a social class "characterized by their ownership of capital and their related culture." A member of the...

, or those who own property and/or the means of production
Means of production
Means of production refers to physical, non-human inputs used in production—the factories, machines, and tools used to produce wealth — along with both infrastructural capital and natural capital. This includes the classical factors of production minus financial capital and minus human capital...


See also

  • Asset allocation
    Asset allocation
    Asset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame.-Description:...

  • Basel I
    Basel I
    Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee in Basel, Switzerland, published a set of minimal capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten countries...

  • Basel II
    Basel II
    Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...

  • Capital structure
    Capital structure
    In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...

  • Financial risk management
    Financial risk management
    Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc...

  • Financial services conglomerate
  • RAROC, risk-adjusted return on capital
  • RORAC, return on risk-adjusted capital
  • Solvency II
    Solvency II
    The Solvency II Directive is an EU Directive that codifies and harmonises the EU insurance regulation. Primarily this concerns the amount of capital that EU insurance companies must hold to reduce the risk of insolvency....

External links

  •, Economic Capital and the Assessment of Capital Adequacy Federal Deposit Insurance Corporation
    Federal Deposit Insurance Corporation
    The Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...

  •, "Basel Committee, Bank for International Settlements"
  • Economic Capital - A Preamble
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