Economic capital is usually generated internally by financial companies using estimations and forecasting models. The result is the amount of capital that the company should keep on hand to support risks and stresses.
Economic capital captures the inherent risk of the economic environment, as opposed to regulatory and accounting rules. Because of such a fact, it is thought of as giving a more accurate representation of the solvency of a financial service company.
Measuring economic capital involves rating the risk in a company and the amount of capital needed to support that risk in an adverse scenario. The calculations are usually based on the financial institution’s financial strength and expected losses.
