Discussion On Economic Capital Management Of Small And Medium-sized Joint - Stock Commercial Banks In China

With the progress of China's financial system reform where go-public-frenzy prevails and the benefits of high economic growth persists, many small-to-medium-sized stock commercial banks continue to strengthen their capital adequacy and expand their market presence. Along with four state-owned giants and numerous foreign banks, these smaller public banks have become an increasingly important force in China's financial market.While on this high expansion path, these smaller banks are also taking risks, willingly or not. Some of those risks may expose the smaller banks to huge amount of bad loans that have been afflicting the giant four for over a decade. The tremendous trading loss that Societe Generale suffered due to internal control failure and the more alarming sub-prime crisis have tolled the bell for the global financial market, triggering a wave of study on banking Enterprise-wide Risk Management (ERM) that is intended to minimize the losses from various risk exposures faced by financial institutions today. Starting from the New Basel Accord, this paper introduces the conception of Economic Capital and Enterprise-wide Risk Management in Banking. And based on mature risk management concepts well accepted by the banking industry around the world, this paper introduces a comprehensive ERM framework with a focus on Economic Capital (EC) Management. According to the New Basel Accord, banking risks can be classified into three main categories—Credit Risk, Market Risk, and Operational Risk. Tied to Economic Capital management, advices are given on how to deal with those three risks taking into account the nature of small-to-medium-sized stock commercial banks.This paper compares and analyses various risk indicators and models widely used by financial institutions around the world and sheds light on their merits and limitations. Suggestions regarding what model and indicators to use for China's small-to-medium-sized banks are tailored to meet their current situations and specific needs rather than to simply rely on the most sophisticated models available.