Adoption of Economic Capital Systems Can Boost Shareholder Value New Study Reveals

TORONTO, March 20, 2002 – Financial institutions that do not
disclose their economic capital calculations to shareholders and other stakeholders risk
undervaluing their company, according to a new study by PricewaterhouseCoopers and the
Economist Intelligence Unit (EIU).

Economic Capital: At the heart of managing risk and value
reveals that even though economic capital systems have become increasingly important to
financial institutions’ decision-making, they have not swept the board across the
industry and there are still a large body of companies, investors and analysts who stick
firmly to more traditional growth and margin measurements to guide them in their decisions.

“Economic capital systems are a way of quantifying the
risks faced by a business and making sure that there is enough capital to cover unexpected
losses and that all expected losses are factored into pricing,” said Jerry Whelan,
head of the Canadian banking practice of PricewaterhouseCoopers.

“With financial markets becoming ever more competitive
and volatile, companies are under more and more pressure from stakeholders and
shareholders to generate better and more clearly understood results,” said Jeremy
Scott, global head of financial services at PricewaterhouseCoopers. “Economic capital
is a tool that allows managers to compare performance across the activities of the group
and make better informed investment decisions.”

Financial institutions use economic capital systems for four main reasons:

  • to ensure a safe level of capital to guard against disasters
    and meet regulatory requirements;

  • to ensure that risks are being managed appropriately, and to
    assess whether insurance policies or risk controls are cost-effective;

  • to ensure that the firm is not over-capitalized; and

  • to ensure that capital is being used efficiently to produce
    the best returns, and to assess strategy and to support decision-making.

  • Leading the field are global financial services
    conglomerates, many of which have been using economic capital calculations in some
    departments for years. The challenge for the pioneers now is to extend and develop the
    systems across the whole company.

The key to the success of a good economic capital system is
getting it accepted throughout a company. Senior management buy-in is relatively easy but
in many companies the problems have come further down the management chain. If divisional
managers are resistant to the system then it will have been a costly and ineffectual
exercise. Some financial institutions have ensured their economic capital systems really
do dictate their strategy by linking it to employees’ bonus payments.

“A company’s return on economic capital can give
a far clearer picture of its real returns and changes in shareholder value. Without these
figures, analysts and investors will tend to make conservative assumptions that will, in
all likelihood, undervalue the company,” said Phil Rivett, global banking &
capital markets industry leader, PricewaterhouseCoopers. “This should provide
companies a real incentive to improve their disclosure of economic capital and be more
transparent in their reporting. It could help to raise their share prices, lower the cost
of capital and increase the credibility of management.”

“In Canada, most major financial institutions are
already developing or enhancing their economic capital models to better measure the risks
and returns of their businesses and allocate capital–to meet Basel II
requirements–and as a vehicle to increase the transparency of their reporting to
stakeholders,” said Troy Maxwell, a partner in PricewaterhouseCoopers’ Canadian
financial risk management practice. “We work with a number of financial institutions
in developing components of their economic capital models, assessing their Basel II
readiness, and improving transparency through value-based reporting.”

The central bank governors of 10 countries, including the U.K., U.S. and Canada,
established the Basel Committee in 1974. The committee formulates broad supervisory
standards and guidelines for the banking industry and recommends statements of best
practice, working in conjunction with each country’s own national systems. In this
way, it encourages convergence towards common approaches and common standards without
attempting detailed harmonization of member countries’ supervisory techniques.

About the PricewaterhouseCoopers/Economist Intelligence Unit Study

Economic Capital: At the heart of managing risk and value
is the second in the series of PricewaterhouseCoopers financial services e-briefing
programme. This e-briefing, written in association with the Economist Intelligence Unit,
addresses the concept, the benefits and the implementation of economic capital as it
applies to financial services institutions. As part of the research both substantial desk
research and a series of in-depth interviews took place with leading figures on economic
capital in January and February 2002. Interviews were conducted with over thirty
executives worldwide at leading banks, insurers and regulators. The complete study is
available from PricewaterhouseCoopers global financial services Web site,

Economic capital is at the heart of managing risk and value

About PricewaterhouseCoopers

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skills of more than 150,000 people in 150 countries, we help our clients solve complex
business problems and measurably enhance their ability to build value, manage risk and
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( and
its related entities have more than 5,900 partners and staff and offices in 26 locations.

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and other member firms of the worldwide PricewaterhouseCoopers organization.