Problem description:

It should be a tool to balance risks and benefits, so it should be used in commercial banks.

Analysis:

Risk-adjusted return on capital (RAROC) theory

The theory of risk-adjusted return on capital (RAROC) was first put forward by new york Banker Trust Company in 1970s, which was later merged by Deutsche Bank.

According to this theory, when evaluating its profitability, banks must consider how much risk they have taken. If the risk of an enterprise is high, the expected loss will usually be great, and the unexpected loss will also be great. Even if an enterprise has a high nominal income, its capital profit rate is not necessarily high or even negative compared with the high potential loss and the economic capital it occupies (equal to unexpected loss).

The calculation formula of risk-adjusted return on capital (RAROC) is:

1, the formula published by China Banking Regulatory Commission.

RAROC = (income-expected loss)/economic capital

2. The original formula (the head office is applicable to the branch office)

RAROC= (income-expenditure-unexpected loss)/capital versus unexpected loss.

= (Income-Expenditure-Economic Capital)/Economic Capital

= (book profit-economic capital)/economic capital

3, the international general basic formula

RAROC = (net profit after tax-cost of capital)/economic capital

4. Improved formula (applicable to branches of the Head Office)

RAROC

= (book profit+adjustment items-economic capital × average rate of return of economic capital)/economic capital

The risk-adjusted rate of return on capital can quantify the risk (foreseeable loss in the future) as the current cost, directly adjust the current profit, and consider the capital reserve required for possible unexpected losses, so that the bank's income is directly linked to the risks it bears.