The Fed’s Economic Capital Metric: A Holistic View of Bank Solvency

The New York Fed (they are on a great roll lately with their research!) just released a really interesting piece called “Economic Capital: A Better Measure of Bank Failure?” (https://lnkd.in/dCNeSKWf) and I think it speaks to something many of us in risk management have been talking about for years.

The researchers built a solvency metric called Economic Capital (EC) which is basically the present value of a bank’s assets minus the present value of its liabilities and operating expenses as well as a stressed version called Run Economic Capital (R-EC) that simulates a run of uninsured deposits. 

What they found is that these measures would have identified problem banks much earlier than traditional accounting ratios like tangible common equity.

What’s fascinating is that this approach isn’t entirely new. In many ways, it mirrors the economic value of equity (EVE) analyses that banks already run internally for interest rate risk. The difference is that the Fed’s version goes further as it pulls in market value changes, deposit run behavior, and credit spreads to create a more complete picture of solvency.

That’s the real takeaway for me.

For too long, many banks have viewed these risks in silos - interest rate risk on one report, liquidity risk on another, credit risk under CECL somewhere else. But real-world stress doesn’t happen in silos. When rates move, deposits shift, and credit losses follow.

The Fed’s framework is a reminder that a holistic modeling approach that ties together earnings, liquidity, and credit impacts under a consistent economic view is essential for understanding true risk to capital and franchise value.

Many institutions already have the pieces: ALM models, CECL models, liquidity stress testing. The next step is connecting them, aligning assumptions, and thinking in terms of long-term economic value, not just short-term earnings volatility.

That’s where the real insight lies and where modeling and model risk teams can add the most value.