Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 4 Figure 2: Calculating Capital Adequacy for Economic Value 1.2.2 Net Assets The net assets for a company (Figure 2) are long-term assets and short-term assets and liabilities, including such items as collateral and margin requirements. The methods to determine this component are discussed in Section II. 1.2.3 Debt As is evident from Figure 2, debt and debt-like instruments reduce net assets. All forms of debt should be accounted for in this component. Debt should reflect the dollar value of the claims on a company that third parties hold as a result of financing or commercial contracts. This includes both on- and off-balance sheet debt. On-balance sheet debt includes debt obligations such as commercial paper, first mortgage bonds, capitalized leases, and deferred taxes. Examples of off-balance sheet debt are operating leases, guarantees, and unfunded pension obligations. 1.2.4 Economic Capital and Its Components Economic capital, the third component of the capital adequacy framework, is the capital a company is required to hold to support the risk of unexpected loss in the value of its portfolio. Economic capital should encompass all risk classes (market, credit, operations, and operational) the enterprise faces (Figure 3). Net Assets Debt Economic Capital - Capital for risk or uncertainty in value Excess or Shortfall