By Pieter Klaassen
Managers can installation and deal with fiscal capital extra successfully once they know how their judgements upload price to their businesses. monetary Capital: the way it Works and What each supervisor must recognize offers new how one can outline, degree, and enforce administration techniques by utilizing fresh examples, many from the sub-prime obstacle. The authors additionally speak about the position of financial capital in the broader context of administration duties and actions in addition to its relation to different hazard administration instruments which are on hand to the fashionable danger supervisor. Explains how one can use monetary capital in balancing possibility and go back Evaluates strategies to difficulties encountered in setting up an fiscal capital framework Emphasizes instinct attracts designated recognition to embedding chance modelling methods inside of fiscal capital frameworks
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Extra resources for Economic Capital: How It Works, and What Every Manager Needs to Know
Economic capital, however, is an abstract quantity, due to the fact that it is a single composite number. This is both its weakness and its strength. The weakness is that an increase of economic capital does not tell exactly which underlying risks are increasing. Are default rates increasing, are concentrations increasing, or something else? Further analysis needs to be performed in order to provide the answer. Hence, monitoring economic capital cannot replace the monitoring of the underlying drivers of risk.
6. 3 Economic Capital and Portfolio Management Economic capital and RAROC were developed in the first instance to manage loan portfolios. RAROC is a practical measure to evaluate ex-ante whether the riskadjusted return on a loan is deemed sufficient. Inputs to the calculation include default probability of the borrower, collateral, loan maturity, and the impact of loan covenants. Hence, the consequences of alternative loan structures on the expected profitability of the loan can be determined, which can help the relationship manager and credit officer to optimally structure and price the loan.
Managers should be aware of the consequences of such a choice, because in principle the franchise value should be included if the firm’s objective is to maximize shareholder value. 8. 3 37 Which Risks to Include in Economic Capital In this section we provide an overview of the main risk types for a financial institution. We distinguish three categories of risks: position risks, inherent risks, and model risks. We discuss each of these categories in turn. Subsequently, we consider the question, which of these risks can cause changes in the value of the institution’s capital, and therefore should be included in the calculation of economic capital?