Definition
Risk-Adjusted Return on Capital (RAROC)
RAROC measures the return a bank earns on a loan or business relative to the economic capital it must hold against the risk taken.
RAROC divides risk-adjusted income (revenue less expected losses and costs) by the capital allocated for unexpected losses. It lets a bank compare the profitability of different products and clients on a like-for-like, risk-aware basis.
By pricing in the capital cost of risk, RAROC discourages chasing high-yield but capital-hungry or loss-prone lending. Indian banks use such frameworks to allocate capital toward businesses that earn above their cost of equity, improving overall ROE and CRAR efficiency.
Related terms
- Capital Adequacy Ratio (CAR / CRAR)The Capital Adequacy Ratio, also called CRAR, is the ratio of a bank's capital to its risk-weighted assets, measuring its ability to absorb losses.
- Risk-Weighted Assets (RWA)Risk-Weighted Assets are a bank's assets weighted according to their credit risk, used as the denominator in capital adequacy calculations.
- Return on Equity (ROE) for BanksFor a bank, Return on Equity is net profit as a percentage of average shareholders' equity, reflecting the return generated on the capital owners have invested.
- Expected Credit Loss (ECL)Expected Credit Loss is a forward-looking provisioning model under Ind AS 109 that estimates likely loan losses based on probability of default, not just incurred defaults.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.