Economic capital
Economic capital is like a piggy bank that a bank or a company keeps aside to protect itself from unexpected financial losses. Just like how you keep some of your money saved in a piggy bank for a rainy day.
Suppose you want to buy a toy that costs $10 and you have $15 in your piggy bank. Instead of spending all the money, you keep $5 aside in case you need some money in the future.
Similarly, the bank or the company keeps economic capital aside to cover unexpected losses that might happen due to economic downturns, natural disasters, or any other reasons that are beyond their control.
The economic capital ensures that even if something bad happens, the bank or company has some money to fall back on without having to shut down or go bankrupt. It is like a backup plan for them to be prepared for any kind of worst-case scenario.
Suppose you want to buy a toy that costs $10 and you have $15 in your piggy bank. Instead of spending all the money, you keep $5 aside in case you need some money in the future.
Similarly, the bank or the company keeps economic capital aside to cover unexpected losses that might happen due to economic downturns, natural disasters, or any other reasons that are beyond their control.
The economic capital ensures that even if something bad happens, the bank or company has some money to fall back on without having to shut down or go bankrupt. It is like a backup plan for them to be prepared for any kind of worst-case scenario.
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