Risk Adjusted Return On Capital (RAROC) is an adjustment to the return on an investment that accounts for the element of risk. It acts as a validation tool to decide whether to go ahead with a transaction, lending or project or not. RAROC also gives decision makers the ability to compare the returns on several different projects with varying risk levels.
Funds Transfer Pricing (FTP), cost allocation, revenue capture and attribution and capital computation frameworks are the building blocks of any good RAROC framework. The sophistication level of a RAROC Model depends on the accuracy and granularity of its components like revenue, costs, expected loss and capital.
Aptivaa has designed an in-house three layered accelerator for computation of RAROC accounting for wide range of inputs that are required. This easily customizable accelerator mitigates many of the key challenges faced in computation of RAROC:
- Customer level credit risk mitigation
- Appropriate allocation and optimization of Collaterals on the basis of LGD and Haircuts
- Hurdle Rate Calculation through CAPM and COE approaches