What is RAROC for a bank?

By Guidelines

What is RAROC for a bank?

Banks utilize RAROC (risk-adjusted return on capital), a risk-based profitability measurement, to assess the efficiency of their business relationships with corporations. Similarly, savvy treasurers use the tool to monitor costs and ensure competitive pricing in their banking relationships.

How do you calculate risk capital?

What Is the Risk-Adjusted Capital Ratio?

  1. The risk-adjusted capital ratio is used to gauge a financial institution’s ability to continue functioning in the event of an economic downturn.
  2. It is calculated by dividing a financial institution’s total adjusted capital by its risk-weighted assets (RWA).

What is Raroc framework?

Risk-adjusted return on capital (RAROC) is a risk-based profitability measurement framework for analysing risk-adjusted financial performance and providing a consistent view of profitability across businesses. The concept was developed by Bankers Trust and principal designer Dan Borge in the late 1970s.

What is the formula used to calculate RAROC?

The formula used to calculate RAROC is: Expected loss = average loss expected over a specified period of time In financial analysis, projects and investments with greater risk levels must be evaluated differently; RAROC accounts for changes in an investment’s profile by discounting risky cash flows against less-risky cash flows.

What does RAROC stand for in return on investment?

Updated Apr 17, 2019. Risk-adjusted return on capital (RAROC) is a modified return on investment (ROI) figure that takes elements of risk into account.

Why is it important to understand the RAROC model?

Since most banks measure their efficiency through a RAROC model, it is important to understand its evolution. Arising out of economic theories from the 1970s, the formula optimizes the allocation of bank capital by determining an appropriate measure of risk-adjusted return.

Who is the creator of the RAROC metric?

The RAROC metric was developed during the late 1970s by Bankers Trust, more specifically Dan Borge, its principal designer. The tool grew in popularity through the 1980s, serving as a newly developed adjustment to simple return on capital (ROC).