Showing posts with label The Economic Capital Management. Show all posts
Showing posts with label The Economic Capital Management. Show all posts

Tuesday, August 2, 2011

The Economic Capital Requirements

The economic method goes further in the correlation of risks. Thus, the approach in terms of economic capital it often leads to a discussion of possible spin-off or termination of activities too inefficient because too greedy in equity (although sometimes very profitable). This view of risk thus favors an approach that is more conservative but also more efficient in the management of financial institutions.

Based on calculation methods close, the two types of capital are in fact in the service of distinct interest. Regulatory capital are primarily intended to maintain the solvency of all financial markets in order to avoid systemic risk, with, ultimately, the aim of guaranteeing the rights of depositors. And, in addition to these economic goals, regulation responds to political ends, as shown in the measure of risk for companies. Indeed, the method of calculating the risk Basel II is a purpose not to penalize SMEs in their research funding from major groups.

Conversely, the economic capital requirements respond first and foremost the concern to maximize business performance, and taking into account the risk is on the basis of this single purpose. Market stability, which is an end in itself in the regulatory framework is a result driven by the desire to improve the profitability of each financial institution.

Thus, the changes marked by the Basel II promote convergence of regulatory capital to their economic equivalents. But if the approach in terms of economic capital can meet some regulatory requirements, it remains primarily a lever that should enable financial institutions to improve and better manage financial performance.

The economic approach thus requires overcoming the only framework set by the Basel Committee, which is reflected in the efforts and significant investments in collecting the necessary data and developing models related. A close collaboration between the Risk Management, Finance and the various trades is also required with a strong involvement of the "top management" to ensure proper deployment of the approach in the establishment. So many projects and milestones that represent the next challenges banks for years to come...

Friday, July 29, 2011

The Economic Capital Management

Beyond these differences on the nature of the risk taken into account, the two types of methods are opposed to their method of calculation. Indeed, the peculiarity of the economic capital is that it incorporates the correlations between micro-economic risk of the counterparty in question and the macroeconomic risks that could affect it. The economic sector of the counterparty or its geographic location and are included in the measure of risk, so you can enjoy the most exhaustive possible potential failures.

More broadly, the sensitivity of the consideration to changing the general economic situation is also a factor in determining the economic capital, through the calculation of the coefficient R2. Thus, while regulatory capital stops at the theoretical definition of the risk of the counterparty, the internal model for determining the economic capital takes into account economic conditions and interdependencies of various factors, allowing a more detailed assessment of risk and therefore economic capital to put in front of the activity.

Specific objectives in the economic capital are an essential instrument of strategic management

Economic capital should actually meet three objectives nested, with the backdrop of the profit motive of financial institution:

* Assessment of risk-adjusted returns: in particular through the calculation of RAROC (Risk Adjusted Return on Capital). The RAROC measures the rate of return of an activity by adjusting the level of capital employed by the risk. Economic capital thus defined to measure the financial performance of the activity in the expected benefits related to capital needed to cover it.
* Portfolio Management: Once the risk-adjusted returns calculated, it becomes possible to compare the actual performance of various businesses of the bank.
* Strategic management activities: economic capital thus enables the bank to arbitrate between the different professions in order to optimize the use of capital.

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