Wednesday, July 27, 2011

Regulatory Capital



With the reform of the Cooke ratio implementation through the Basel II regulations, the calculation of regulatory capital tends to approach the method highly economical. Based on a finer appreciation of risk capital. Regulatory and would achieve the same objectives as economic capital. But if the effects induced by the application of Basel II can approach the objectives of economic capital, economic capital remains under a real added value in relation to regulatory capital for strategic management activities.


The economic capital of a financial institution, amount of capital required to meet unexpected losses (unexpected loss) is defined using internal models for each activity. The Cooke ratio in turn was based on a more comprehensive approach to risk, not broken down by activity. Conversely, regulatory capital as defined by Basel II is characterized by a measure of individual risk, including segmentation between risk classes, which brings them closer to an economic vision. Moreover, the loss rate (LGD) or exposure to default (EAD) are factors common to both types of methods in determining the capital.

However, despite these similarities, a fundamental difference between the two methods is the notion of risk considered. Indeed, the risk of "outstanding" included in the internal economic capital model is wider than the risks involved in the Basel II regulations, and cover the face of unexpected losses does not necessarily require an increase in equity . Indeed, the economic capital includes the entire system set up on the line of activity. Thus, the managerial qualities such coverage may be the face of extraordinary losses considered in determining the economic capital.

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