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The Actuary The magazine of the Institute & Faculty of Actuaries

Book review

Economic capital and financial risk management for financial services firms and conglomerates

This is the imposing title of a useful new book by actuaries Bruce Porteous (currently head of financial risk with Standard Life Bank) and Pradip Tapadar (currently a research associate at Heriot-Watt University). The book (ISBN 1-4039-3608-0) is published by Palgrave Macmillan.

To this reviewer the book is a very good introductory text in financial risk management, which illustrates particularly well the value of actuarial modelling techniques. The treatment of market risk in all forms of institution is perhaps the strongest element of the book, and the authors make clear at an early stage their view that management action – rather than holding capital – is much the most important mitigant or absorber of operational and liquidity risks. A powerful element of the book is a set of comparisons which shows that Basel 2 Pillar 1 capital requirements are ‘generally very poor approximations to economic capital’ for many banking products.

One might have wished to see a little more on the potentially conflicting interests of shareholders and regulators and on the distinction between risks to firms and risks to the (banking) system. It may also be the case that the authors slightly overestimate the potential of stochastic approaches. These however are minor quibbles prompted only by the breadth of the treatment by Porteous and Tapadar. This book will be particularly valuable to actuaries who want to understand the potential to apply our toolkit in a broader context, and is a welcome antidote to our usual tendency to know more and more about less and less – it is well worth reading for that reason alone.