Toronto, December 21, 2005 – Use of economic capittal is seeing significant momentum within the financial services sector around the globe. Canadian banks are well ahead and are actively employing economic capital as a business tool, a new study by PricewaterhouseCoopers (PwC), in association with the Economist Intelligence Unit, has found. The survey revealed that 44% of financial institutions worldwide already use economic capital with a further 13% planning to do so within the next 12 months. However, a quarter of companies (25%) said that they have no intention of adopting economic capital at all and a third are sceptical about its value.
The study, Effective capital management: Economic capital as an industry standard? sought views from more than 200 senior financial services executives globally. Economic capital and other advanced risk-based capital methodologies enable organizations to quantify the risks they face, the capital needed to cover them, and the real risk-adjusted returns that are being made. From the impact of Hurricane Katrina on re-insurers to the risks facing mortgage lenders of a potential housing crash economic capital can help protect against loss. Other industries are following the example set by financial institutions in the use of economic capital and are leveraging best practices already in place by trend-setters like Canadian banks.
“Encouraged by new regulations like Basel II, the big six Canadian banks have already done a great deal of work on economic capital models. They continue to develop and refine these on an ongoing basis,” said Diana Chant, Partner and Leader of the PwC Financial Services Practice in Canada. “The challenge is how to expand its use into core business units and determine the right balance of disclosure to the capital markets.”
In the global survey, PwC found that the survey respondents believe that economic capital is more valuable to their business in helping to define their appetite for risk and set risk limits rather than as a means of meeting regulatory capital requirements. Over 95% of respondents who have implemented or plan to implement economic capital have either already achieved, or expect to achieve, a better allocation of capital than under a regulatory capital model.
Many institutions are not exploiting the full business value of economic capital. The study found that levels of understanding among senior management about the business applications of economic capital vary greatly between institutions.
“Economic capital is quickly gaining ground within financial services and other industries on a global scale,” said Chant. “In the right hands economic capital is a powerful management tool which can provide a better understanding of the trade-off between risk and reward, leading to more incisive decision-making and more sustainable value creation.”
Banks are more active in disclosing economic capital than insurers or other financial services companies. Around 70% of the world’s top 50 banks disclose usage of economic capital to their shareholders via their annual report and 50% disclose economic capital results by business units both in their annual report and quarterly financial results ( Economic Capital Disclosures at Top 50 World Banks, PricewaterhouseCoopers analysis 2005). Top banks from Canada, Germany and Spain reported on economic capital in all cases.
“It will take time for risk-based capital methodologies to become a financial services industry standard both here in Canada and around the world due to the differences in the assumptions and approaches,” says Chant. “However, each step forward not only bolsters the ability of financial companies to make better business decisions but also strengthens risk management.”
Effective capital management: Economic capital as an industry standard? is available to download at www.pwc.com/financialservices . For more information please contact Carolyn Forest, 416-814-5730, [email protected] .
PricewaterhouseCoopers ( www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 130,000 people in 148 countries work collaboratively using Connected Thinking to develop fresh perspectives and practical advice. In Canada, PricewaterhouseCoopers LLP ( www.pwc.com/ca ) and its related entities have more than 4,300 partners and staff in offices across the country.