Hi there I was wondering if someone could explain the difference between regulatory and economic capital for me. My current understanding is that the regulatory capital is what we need to hold due to regulation. This can be determined with a pre-determined formula or an internal model. Then economic capital is the capital that the company believes is appropriate to hold to cover their risks according to their risk appetite. Where I am getting confused is that would economic capital be more of an internal measure and then the regulatory capital is what has to be published and adhered to? Then would this mean that the operational capital can't be less than the regulatory capital? Also would the economic or regulatory capital values be published ?
You are right, the economic capital is more of an internal view/measure, and the regulatory capital is what has to be adhered to, as set by the regulator. The economic can be more or less than regulatory, and both may be published, perhaps in company reporting. Any investor, or prospective investor, may want to actually see both, to get an understanding of the risks facing the company as viewed by the regulation, and as viewed by the company itself too. Operational risk would feature into the calculation for capital to be held, and is one component of the capital requirement (others being market risk, underwriting risk, credit/default risk). Aman ActEd Tutor
