Economic Capital

Economic capital is the amount of capital a company, especially a financial institution, needs to cover its risks and ensure it remains solvent. It represents the amount of money that a company should hold to protect itself against unexpected losses, calculated based on its own internal risk models rather than regulatory requirements. Economic capital helps companies assess their financial health, allocate resources effectively, and manage risks. This measure is critical for banks and insurance companies to ensure they have enough capital to support their operations during adverse economic conditions.

Example

A bank calculates its economic capital to ensure it can cover potential loan defaults and other financial risks during an economic downturn.