Economic Capital Gauged

Abstract

The Basel Committee's release of the new Basel Accord and its new operational risk class are raising questions on how regulatory capital for operational risk should be determined and is transforming the banks' view of economic capital. This paper investigates the relationship between publicly available economic capital - and regulatory capital figures from 2002 and 2003, and compares these with figures from the Basel Committee's Quantitative Impact Studies. The focus will be constrained to top 50 internationally active banks. Initially, many if not most banks will be using the simplest regulatory method, the Basic Indicator Approach, to calculate the operational risk capital charge. Hence, the Basic Indicator Approach is applied in order to study the impact of different definitions of gross income resulting in different levels of operational risk capital charges. Finally, the comprehensiveness of year-end economic capital disclosure in 2002 and 2003 annual reports of the top 50 banks is examined to reflect the considerable evolutionary change that the banking industry is undergoing.

Keywords: Economic capital, risk capital, regulatory capital, capital charge, operational risk

JEL Classification: C44, G21, M00