Speaking, in business enterprises, risk is
traded off against benefit. RAROC is defined as the ratio of risk adjusted
return to economic capital.
The economic capital is the amount of money which is needed to secure the
survival in a worst-case scenario, it is a buffer against expected shocks in
market values. Economic capital is a function of market risk, credit risk, and operational risk, and is often calculated by VaR.
This use of capital based on risk improves the capital allocation across
different functional areas of banks, insurance companies, or any business in
which capital is placed at risk for an expected return above the risk-free rate.
RAROC system
allocates capital for two basic reasons:
1.
Risk management
2.
Performance evaluation
For risk management purposes, the main goal of allocating
capital to individual business units is to determine the bank's optimal capital structure—that is economic capital
allocation is closely correlated with individual business risk. As a
performance evaluation tool, it allows banks to assign capital to business
units based on the economic value added
of your unit.
No comments:
Post a Comment