Some basic relationship between economic capital & regulatory capital

[Liming]

Dear David,
I’ve had some confusion, misunderstanding and doubts when doing 09 Level II Annotated Power Practice. Appreciate your kind help on this!

In question 23, you answered that the following statement is true:
III. Firms whose capital exceeds their required regulatory capital are firms that employ their capital inefficiently and their shareholders would benefit if they used some of their capital to repurchase shares or increase dividends.
I’m confused over this because I think there can be cases in which firm-decided economic capital is higher than their required regulatory capital and if firms are operating and holding this higher capital, I think the firm is employing their capital efficiently since it is equal to the amount of economic capital determined within the business as optimal economic capital, although higher than regulatory.

Thank you for your enlightenment and correction!
Cheers
Liming
16/11/09

 

[David Harper CFA FRM]

Hi Liming,

In my defense, that is GARP's question (they write the "source" and then my questions are the "my adds"). Nevertheless, you are ABSOLUTELY 100% CORRECT (per Stulz & Nocco ERM, as one example, but there are other!) and I am embarrassed I even let this pass thru my filter...I am dismayed that (III) is considered true, it is contrary to Stulz....David