Economic capital is the total amount of capital risk held by companies of financial services to allow it to overcome difficulties. An example of this difficulty is credit risks. They do this often by using some measures of risks like the value at risk (Var). Economic capital might also be used in the reporting and measuring operational market risks that occur may be in a financial organization. Economic capital value is very important especially in a financial organization through the following ways that help it to manage rising risks the organization. The management of a bank can use the estimates of economic capital (EC) to allocate or distribute capital across their stream of businesses, and also to promote the units that provide good desired profits per unit of risk.
Most financial institutions and even banks are faced with very long uncertainties of their future that they do intend to be responsible or accountable for. When a bank may want to determine what amount of capital they need for them to remain solvent in a time horizon or at a confidence level, economic capital (EC) is that which is considered as the capacity of capital risk from the perspective of the bank.
Economic capital (EC) aims at supporting the decisions of a business (Barrieu and Ravanelli, 13). The estimates of economic capital (EC) can also be covered by Tier 1, Tier 2 and Tier 3 elements, or the definitions used by agencies at a rating, and also other capital types such as profit unrealized, planned earning or the implicit government guarantee. Most banks may use developed internal models to their economic capital.
Value-at-risk (VaR) models are more of economic capital (EC) frameworks for credit risk, markets and other risks too. Capital has become a very scarce resource in the credit crisis globally. The management of capital is foremost driven by some risks. Risks in an organization can trigger big losses that deplete the organization’ s capital.
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