In the latest of eRisk's online conferences, measuring economic capital was the focus as Stephen Bates, director of the risk management group at the Bank of Montreal advocated looking at how firms use economic capital calculations rather than simply coming up with the numbers. Bates describes economic capital as a risk measure by converting the risk of loss into a dollar figure, allowing different types of risk such as market, credit and operational to be combined into a single measure.
Bates also defined what he calls "bottom-up" economic capital calculation as opposed to a "top-down" approach to figuring economic capital numbers. According to Bates, these bottom-up figures can be better used to change business line behavior because they draw directly from the business lines. Bates' description of good economic risk calculation covered the risk of shortfall in earnings or fall in value of financial assets over a yearlong period due to credit, market and operational losses.
Online polls conducted during the conference found that 24 percent of respondents currently have a model for capital allocation/attribution while another 21 percent plan to implement one within the next six months and another 21 percent plan to do so within the next 12 months. In another online poll, 55 percent of respondents indicated that their institutions use economic capital for performance measurement. Additionally, 51 percent use those figures for risk limits and 35 percent for risk appetite. According to the results, Bates emphasized that economic capital is becoming important for distributing capital among competing business lines.