Risk Adjusted Return on Capital

Internal business units compete for the capital, and institutions use RAROC measure to optimize the risk adjusted return at an aggregate level.

We support our clients in developing a comprehensive RAROC framework.

• Identify risks – As a first step, all the risks within the financial institution portfolio are identified.
• Risks are allocated to the respective business units & support functions based on their ability to control that particular risk.
• Risk measurement methodologies are developed. We help our clients with our proprietary methodologies to assess the risks.
• Methodologies may vary based on the complexity of operations of an entity and importantly, by availability of data required for assessment.
• We recommend to use higher of the economic capital or regulatory capital for estimation of Risk Adjusted Return on Risk Adjusted Capital.
• Fund Transfer pricing framework is an important component for assessment of RAROC, as it transfers the interest rate risk and forex risk to the treasury. We help the banks in development & implementation of FTP framework. Less sophisticated banks also use cost of funds as measure instead of proper FTP framework.
• Direct & indirect costs are allocated for assessment of RAROC measure. It’s important to have the right allocation of shared services across businesses, for meaningful measure of RAROC.
• Estimate the hurdle rate i.e. minimum return on capital as desired by its shareholders. It helps the senior management of the institution in accepting or declining a particular transaction.
• Our framework is designed to roll up the RAROC measurement from transaction level to borrower level to the business unit to the institution level. It helps our clients in assessing the performance at different levels and allows them to optimize their offerings/pricing.