Economic capital is a risk measure used by banks to determine the amount of capital they need to hold to remain solvent and cover potential losses:
* Internal Risk Estimates: Unlike regulatory capital, which is determined by external regulatory requirements, economic capital is based on the bank's own risk assessment models and internal estimates of potential losses.
* Risk Types: It considers a range of risks including credit risk, market risk, operational risk, and other financial risks that the bank might face.
* Purpose: The goal is to ensure the bank has enough capital to absorb unexpected losses and to maintain confidence among depositors and investors.
Therefore, economic capital is a measure of the potential losses based on the bank's internal risk estimates.
References: How Finance Works, detailed discussions on economic capital and risk management.