Do you measure and monitor what is strategically important?

ROA and ROE versus Risk Adjusted Returns

Most banks calculate return on asset (ROA) and return on equity (ROE).  Two banks can have identical ROA and ROE calculations but Bank A's loan portfolio is composed of short term homogeneous consumer loans with strong underwriting standards and high FICO scores. Bank B's loan portfolio is composed of large commercial construction loans, close to the bank's legal lending limit, and long term consumer mortgage loans with low FICO scores.

Risk Adjusted Return on Capital (RAROC) or Risk Adjusted Return on Investment (ROI) is the standard for performance evaluation since it looks at capital as a function of risk and return.  Risk Adjusted Returns take into account the inherent risks and places all products on standard metrics for equity or investment deployment.

Using the RAROC methodology Bank A would have a higher RAROC than Bank B.


RAROC=(Revenue - Costs - Expected Loss)/(Expected Loss + Unexpected Loss)

Contact Us:

Gary S. Austin MBA

Consulting Director / Owner

Phone: (843)957-5263 

(revised 11/28/2017)

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