In Focus Risk


Basel II calculates the bank’s overall


As a risk measure, regulatory capital is much less accurate than economic capital. This is understandable considering the two different functions of such capitals


Regulatory capital Regulatory capital is the amount of capital required by regulation and the regulator. For instance, for countries which have


adopted the Basel II accord, Basel II’s Pillar 1 establishes the minimum capital requirement and Pillar 2’s Internal Capital Adequacy Assessment Process will either determine that no additional capital is needed, or that additional capital is required above Pillar 1 levels.


April 2017


minimum-capital requirement as the sum of capital requirements for credit risk, operational risk, and market risk. Examples of solvency regimes include


the European Union’s Solvency Capital Requirement under Solvency II; the US Insurance Risk Based Capital Solvency Framework, which provides a capital- adequacy standard that is related to risk and which provides a safety net for insurers; and the Office of the Superintendent of Financial Institutions’ Minimum Continuing Capital and Surplus Requirements guideline for Canada’s life insurance companies. Even as the core Basel III standards are


being implemented, the shift towards ‘Basel IV’ continues, with the calibration of the leverage ratio either set higher than 3% (as in Switzerland and the United States, and proposed in the United Kingdom), or yet to be determined. Meanwhile, at the same time, new


pressures are emerging, on banks, from stress testing and from wide-ranging revisions to risk-weighted assets, including the Federal


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Reserve’s proposed risk-based capital surcharge for global systemically important bank holding companies.


Economic or regulatory capital As a risk measure, regulatory capital is much less accurate than economic capital. This is understandable considering the two different functions of such capitals. In fact, the regulatory capital was


conceived of to limit the losses incurred by investors in case of bankruptcy by a financial institution. The economic capital, on the other hand,


must be in tune with current economic conditions, as it is meant to ensure that the institution remains solvent even if it is hit by an adverse event. It is important to note that recent


regulatory directives, such as Basel III and CRD IV, are seeking to align regulatory capital levels to economic capital in order to make bankruptcy impossible. Still, the fact that portfolio effects are not


taken into consideration at all under Basel II and Basel III, makes such directives of little practical use. CCR


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