This lesson moves from specific risk types to the holistic, strategic view of risk management and the critical role of capital.

7.1 Enterprise Risk Management (ERM) Framework
ERM is a holistic, strategic approach to managing the full spectrum of risks an organization faces. It moves beyond “siloed” risk management (where each risk type is managed separately) to a comprehensive, integrated view . The goal is to view all risks in an integrated, firm-wide context to support strategic decision-making and optimize the risk-reward trade-off.

7.2 The Basel Capital Framework
The capital of a bank is its “cushion” against unexpected losses. A bank’s capital is its net worth or equity, the difference between its assets and liabilities. Regulatory capital requirements are the cornerstone of banking supervision, designed to ensure banks have enough high-quality capital to absorb losses and remain solvent. The Basel Accords are the global standard .

7.3 The Components of Regulatory Capital
Basel III, the latest iteration, defines a strict hierarchy of capital quality :

• Common Equity Tier 1 (CET1): The highest quality capital, composed primarily of common shares and retained earnings. It must be at least 4.5% of Risk-Weighted Assets (RWA).

• Additional Tier 1 (AT1): Includes instruments like perpetual bonds that can be converted to equity. Together with CET1, Tier 1 Capital must be at least 6% of RWA.

• Tier 2 Capital: Lower-quality capital, such as subordinated debt, which provides a secondary buffer. Total Capital (Tier 1 + Tier 2) must be at least 8% of RWA.

7.4 Pillars of the Basel Accord
The Basel II and III frameworks are built on three “pillars”:

• Pillar 1 (Minimum Capital Requirements): This sets the quantitative rules for calculating minimum capital for credit, market, and operational risk.

• Pillar 2 (Supervisory Review Process): This requires banks to internally assess their capital adequacy (through the Internal Capital Adequacy Assessment Process – ICAAP) considering risks not fully captured in Pillar 1. It also requires banks to conduct stress tests to model their resilience under adverse economic scenarios. The supervisor can impose additional capital requirements based on this assessment .

• Pillar 3 (Market Discipline): This requires enhanced public disclosure of a bank’s risk profile, capital adequacy, and risk management practices.

7.5 Economic Capital
Economic capital is a measure of the capital a bank estimates it needs to cover the risks it has taken, based on its own internal calculations, to a specific confidence level (e.g., to remain solvent with a 99.9% probability). This is distinct from regulatory capital, which is the minimum amount required by the supervisor. A key goal of bank management is to ensure that its economic capital is less than its regulatory capital, signaling that the bank is well-capitalized .