In
finance
Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...
, mainly for financial services firms, economic capital (ecap) 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, such as
market risk,
credit risk,
legal risk
Law is a set of rules that are created and are enforceable by social or governmental institutions to regulate behavior, with its precise definition a matter of longstanding debate. It has been variously described as a science and as the a ...
, and
operational risk. It is the amount of money that is needed to secure survival in a worst-case scenario. 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 stays solvent over a certain time period with a pre-specified probability. Therefore, economic capital is often calculated as
value at risk. 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 climate change, political outbreaks, 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.
In social science
In
social science
Social science (often rendered in the plural as the social sciences) is one of the branches of science, devoted to the study of societies and the relationships among members within those societies. The term was formerly used to refer to the ...
, ''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
natural capital,
cultural capital and
social capital; the latter two represent a type of power or status that an individual can attain in a
capitalist society
A society () is a group of individuals involved in persistent social interaction or a large social group sharing the same spatial or social territory, typically subject to the same political authority and dominant cultural expectations. ...
via formal education or through social ties. Non-economic forms of capital have been variously discussed most famously by sociologist
Pierre Bourdieu.
See also
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Asset allocation
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Basel I
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Basel II
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Capital structure
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Financial risk management
Financial risk management is the practice of protecting Value (economics), economic value in a business, firm by managing exposure to financial risk - principally credit risk and market risk, with more specific variants as listed aside - as well ...
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Financial services conglomerate
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RAROC, risk-adjusted return on capital
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RORAC, return on risk-adjusted capital
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Solvency II
References
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External links
FDIC.gov Economic Capital and the Assessment of Capital Adequacy
Federal Deposit Insurance Corporation
BIS.org "Basel Committee, Bank for International Settlements"
Economic Capital - A PreambleCEIOPS"
{{Sociology-stub
Actuarial science
Financial risk