NEW YORK and LONDON, Dec. 13, 2005 (PRIMEZONE) -- Despite significant momentum behind the use of economic capital within the financial services sector, a new study by PricewaterhouseCoopers, in association with the Economist Intelligence Unit, has found that many institutions are failing to realise the full potential of risk-based capital management as a business tool to enhance their strategic and tactical planning and optimise shareholder wealth.
The study, entitled 'Effective capital management: Economic capital as an industry standard?,' sought views from more than 200 senior financial services executives globally and revealed that 44% of companies 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 of non-adopters are sceptical about the value of economic capital itself.
Economic capital and other advanced risk-based capital methodologies enable financial institutions to quantify the risks they face, the capital needed to cover them and the real risk-adjusted returns that are being made.
The main business reasons cited by survey respondents for the uptake of economic capital are to improve their strategic planning, define their appetite for risk and set their risk limits. Ninety-five percent of companies have or expect to achieve a better allocation of capital using economic capital than under a regulatory capital model.
Yet, in practice many institutions are not exploiting the full business value of economic capital. The study found:
-- Levels of understanding among senior management about the business
applications of economic capital vary greatly between
institutions. Responsibility for managing economic capital still
rests predominately with the risk management function rather than
with the business units.
-- Risk-adjusted performance measures are only infrequently being
used to drive compensation for senior managers and business unit
heads, and risk and financial reporting often remain separate.
-- The results of economic capital calculations are disseminated
patchily within the organisation.
Phil Rivett, partner, PricewaterhouseCoopers, said:
"Economic capital is fast gaining ground within financial services companies globally. 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. However, the evidence from our study suggests that too few senior managers are making the leap."
The study also highlighted that more than one third of companies (36%) do not report economic capital results externally to shareholders and other key stakeholders.
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(a).
Richard Barfield, director, PricewaterhouseCoopers, said:
"Companies are generally not exploiting the full business value of economic capital as it is sometimes seen primarily as an internal tool and not always communicated to institutional investors and other external stakeholders. This could be why investors are regarded by respondents as being the least knowledgeable on the issue of economic capital.
"It will take time for economic capital to become a true industry standard so that shareholders and analysts can realistically compare one institution with another. Each step towards risk-based management of capital not only strengthens the ability of financial companies to make a reasonable return for their shareholders but also strengthens risk management."
Key regional findings include:
-- The U.S. has the least plans to introduce economic capital -- with
37% of U.S. financial institutions saying that they have no plans
compared to only 19% for Asia-Pacific and 27% for Europe.
-- Over the next year Asia-Pacific is more likely than the other
regions to introduce economic capital -- 19% compared to just 7%
from EU and 10% from the U.S.
-- The main reason for adopting economic capital in the U.S. is to
define risk appetite, cited by 79%. For both Europe and Asia-
Pacific the mean reason is to improve strategic planning at 67%
and 68% respectively. The U.S. at 44% is the region least likely
to report economic capital figures externally, compared to Europe,
the lowest at 34%. The U.S. and Europe are most likely to report
in the future, both at 40%.
-- Regulators in Asia-Pacific are least likely to require economic
capital (12% compared to 42% in the U.S.), but it is also the
region that says while economic capital may not be required it is
expected (55% of companies in Asia-Pacific compared to only 15% of
companies in the U.S.).
Notes to Editor
1. 'Effective capital management: Economic capital as an industry
standard?'is available to download at
www.pwc.com/financialservices. To obtain a hard copy, please
contact Vanessa Burgin on 020 7212 1002 or
vanessa.burgin@uk.pwc.com
2. The financial services group of PricewaterhouseCoopers has
developed a global programme of briefings to address key strategic
issues facing the industry with the emphasis on drawing
conclusions about best practice and future trends. Other briefings
in the series include:
-- Offshoring
-- Growth
-- Improving Performance
-- Risk management
-- Governance
-- Rebuilding public trust
-- International Financial Reporting Standards
-- Compliance
-- Restructuring
-- Wealth management
3. PricewaterhouseCoopers (www.pwc.com/uk) provides industry-focused
assurance, tax and advisory services for public and private
clients. More than 130,000 people in 148 countries connect their
thinking, experience and solutions to build public trust and
enhance value for clients and their stakeholders.
Unless otherwise indicated, PricewaterhouseCoopers refers to
PricewaterhouseCoopers LLP a limited liability partnership
incorporated in England. PricewaterhouseCoopers LLP is a member
firm of PricewaterhouseCoopers International Limited.
(a)Economic Capital Disclosures at Top 50 World Banks,
PricewaterhouseCoopers analysis 2005
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