Answer: Economic capital considers correlations between credit, market, and operational risks, while regulatory capital adds them separately.

## Explanation **D is correct.** Economic capital is distinguished from regulatory capital in that it considers correlations between credit, market, and operational risks. Regulatory capital requirements typically require that the separate risks be added to come up with total capital requirements without considering diversification benefits from correlations. **A is incorrect** because this statement reverses the roles - economic capital considers correlations, while regulatory capital adds them separately. **B is incorrect** because both economic and regulatory capital would go up (not down) when correlations between risks decrease, as diversification benefits are reduced. **C is incorrect** because both economic capital and regulatory capital act as a cushion that covers unexpected losses. The key difference is that economic capital is the bank's own internal estimate, while regulatory capital is the amount required by regulators. Economic capital represents a bank's internal assessment of the capital needed to cover unexpected losses at a certain confidence level, taking into account diversification effects across different risk types.

Author: LeetQuiz Editorial Team