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Regulatory and economic decision measures
Over time, minimum required regulatory capital requirements have been increasingly onerous. With the financial crisis of 2007, required regulatory capital frequently eclipse economic capital as legislation such as the Dodd–Frank Act, and Basel III were introduced. An implication of stringent regulatory capital requirements spurred debates on the validity of required economic capital in managing an organization’s portfolio composition, highlighting that constraining requirements should have organizations focus entirely on the return on regulatory capital in measuring profitability and in guiding portfolio composition. The counterargument highlights that concentration and diversification effects should play a prominent role in portfolio selection – dynamics recognized in economic capital, but not regulatory capital.

It did not take long for the industry to recognize the relevance and importance of both regulatory and economic measures, and eschewed focusing exclusively on one or the other. Relatively simple rules were devised to have both regulatory and economic capital enter into the process. In 2012, researchers at Moody’s Analytics designed a formal extension to the RORAC model that accounts for regulatory capital requirements as well as economic risks. In the framework, capital allocation can be represented as a composite capital measure (CCM) that is a weighted combination of economic and regulatory capital – with the weight on regulatory capital determined by the degree to which an organization is capital constrained.