Economic capital is the amount of capital that a firm, usually in financial services, needs to ensure that the company stays solvent given its risk profile. Economic capital is calculated internally, sometimes using proprietary models, and is the amount of capital that the firm should have to support any risks that it takes.

Economic capital is used for measuring and reporting market and operational risks across a financial organization. Economic capital measures risk using economic realities rather than accounting and regulatory rules, which have been known to be misleading. As a result, economic capital is thought to give a more realistic representation of a firm's solvency.

A bank wants to evaluate the risk profile of its loan portfolio over the next year. Specifically, the bank wants to discern the amount of economic capital needed to absorb a loss approaching the 0.04% mark in the loss distribution corresponding to a 99.96% confidence interval. The bank finds that a 99.96% confidence interval yields $1 billion in economic capital in excess of the expected (average) loss. If the bank had a shortfall in economic capital, it could take measures such as raising capital or increasing the underwriting standards for its loan portfolio in order to maintain its desired credit rating. The bank could further break down its loan portfolio in order to evaluate if the risk-reward profile of its mortgage portfolio exceeded its personal loan portfolio.

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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… Insurance: Mathematics and Economics. Volume 35, Issue 2, 11 October 2004, Pages 299-319. Insurance: Mathematics and Economics … In particular, we formalize a procedure to determine (i) the optimal amount of economic capital to be held by a financial conglomerate, (ii …

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Banks use it to evaluate their loan portfolios over time and determine how much risk they can take on in order to maintain their desired credit rating. They also use it to break down their portfolios into smaller parts in order to evaluate if certain types of loans have higher or lower risks than others. This allows them to make better decisions about what kinds of loans they want to offer customers based on the bank's own preferences and standards for acceptable risk levels.

Economic capital is the amount of capital that a firm needs to ensure that it stays solvent given its risk profile.

Economic capital measures market and operational risks across an organization.

The total physical capital at any given moment in time is referred to as the capital stock (not to be confused with the share capital of a business entity).

You could look at your loss distribution curves for different confidence intervals (or other probability distributions) and see where you fall short compared with your expected losses (the average).

Capital can be increased by human labor, and does not include certain durable goods like homes and personal automobiles that are not used in the production of saleable goods and services.

Accounting rules are misleading, while economic reality is not. As a result, economic capital gives a more realistic representation of solvency.

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