Strategic Capital: Defining an Effective Real-World View of Capital

The advent of the Comprehensive Capital Analysis and Review (CCAR) stress testing process as the dominant regulatory measure of bank capital adequacy in the US has established a new and complex framework for financial institutions to measure and manage risk.

Stress testing arguably provides a more realistic view of capital adequacy than previous measures such as economic capital and Basel regulatory capital. However, bank management now face difficult decisions on how to use stress testing for internal decision making, whether to move away from economic capital, and how to manage the uncertainty of a Fed-led stress testing standard.

In our perspective, Strategic Capital: Defining an Effective Real-World View of Capital, we address the questions by proposing that banks take back the lead in advancing risk measurement by developing Strategic Capital, a bank-led view of risk and capital through the stress testing lens. Strategic Capital can replace many but not all of the traditional uses of economic capital and, most importantly, can be used to drive top-of-the-house economic decisions in a way that aligns with the real-world constraints imposed by the CCAR process.