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Answer: Economic capital is an internal risk measure that reflects the amount of capital needed to ensure a company remains solvent with a high level of confidence, given its risk profile.
## Explanation **D is correct.** Economic capital is a bank's own internal estimate of the capital it requires to absorb unexpected losses and maintain solvency with a high level of confidence. It reflects the institution's specific risk profile and is used for internal risk management purposes. **Why other options are incorrect:** - **A is incorrect:** Regulatory capital for credit risk is designed to cover losses that are expected to be exceeded only once every thousand years (not ten years), representing a much more conservative standard. - **B is incorrect:** Equity capital (not regulatory capital) is referred to as going concern capital because it absorbs losses while the bank remains in business. Regulatory capital is externally imposed by regulators. - **C is incorrect:** The most important capital is equity capital, not regulatory capital. Regulatory capital does not equal expected losses; it's designed to cover unexpected losses above expected losses. Economic capital serves as an internal risk management tool that helps banks maintain target credit ratings and allocate capital efficiently across business units.
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A risk analyst at a financial institution is preparing a report on capital requirements for the senior management team to be used in risk appetite discussions. The analyst compares regulatory capital and economic capital requirements in the report. Which of the following statements is correct for the analyst to include in the report?
A
The regulatory capital for credit risk is designed to be sufficient to cover a loss that is expected to be exceeded only once every ten years.
B
Regulatory capital is sometimes referred to as going concern capital because it absorbs losses incurred while the bank is still in business.
C
The most important capital for a bank is regulatory capital, which equals the bank's estimate of its expected losses.
D
Economic capital is an internal risk measure that reflects the amount of capital needed to ensure a company remains solvent with a high level of confidence, given its risk profile.
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