Integrated Capital Management: ICAAP and ORSA

Bogie Ozdemir

Capital management is not a new concept for financial institutions. They have a long history of managing their capital levels with respect to regulatory requirements, rating agency expectations and internal assessments of their current and future capital needs. However, it is not typically a capital planning and budgeting process to integrate the demand and supply sides of the capital.

In the past, pre-Basel II practices in the assessment of capital adequacy were overly simplistic. Many FIs considered their capital level adequate as long as their book value of equity was larger than the maximum of economic capital, regulatory capital and rating agency capital. The difference between the available capital (measured in book value of equity, representing the supply side of the capital) and the risk capital (measured in terms of economic, regulatory and/or the rating agency capital, representing the demand side of the capital) is effectively the surplus capital or capital buffer. This was an overly simplistic assessment of capital adequacy as there were no explicit linkages between the size of the capital buffer (surplus) and the business cycle, risk appetite, corporate and risk