On November 6, the Fed of New York published a Liberty Street Economics blog post analyzing the effectiveness of a new metric for identifying bank failure risk called Economic Capital (EC). Unlike traditional solvency measures, such as regulatory capital and tangible common equity, the EC calculation relies on estimates of the present value of bank assets, liabilities and expenses, and takes into consideration real-time changes in interest rates and credit spread.
The Fed’s analysis found run-EC (R-EC), which models the impact of a depositor run, appears to identify failing banks earlier and more accurately than conventional metrics. When applied retrospectively to the five-year period leading up to the March 2023 banking crisis, R-EC signaled high insolvency risk for affected banks as early as mid-2022, while traditional metrics remained within industry ranges. The overall findings suggested that EC could be a useful tool for monitoring the financial health of individual banks and risks at the broader banking system level.
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