What is economic capital?

There are three types of capital viz. Regulatory capital, Book capital, and Economic capital. Regulatory capital is the amount of capital a bank is required to hold as per the stipulations prescribed by the banking regulator of the country. Book Capital is the actual capital that the bank has, which includes equity capital, loans, and advances extended by the bank. Economic capital (EC) also known as risk capital refers to the amount of capital that a bank estimates to run the business and remain solvent at a given confidence level and time horizon.

Economic Capital is defined by the Global Association of Risk Professionals (GARP) as the capital cushion required against the underlying credit, market, and operational risk exposure of a banking organization. In simple words, economic capital is the estimated amount of capital need to be maintained by a bank to cover possible losses from overall risk faced by the bank including credit risk, market risk, and operational risk. It is calculated by a bank using its own internal risk models in terms of economic realities rather than potentially misleading regulatory or accounting rules. The economic capital estimated by a bank is usually over and above regulatory capital.