Risk, returns and capital 59
system to analyse the capital requirement has been constructed
that enables better and more efficient risk assessment, provides
insight into the degree of risk diversification and is a pricing instru
ment for loans granted. More than before, debtor risk will be transla
ted into the rate charged.This rate can be derived directly from the
minimum return deemed necessary by the bank on the economic
capital that must be set aside for the debtor.
Relating the profit achieved on a certain activity to the capital
required for that activity produces RAROC, the risk adjusted return
on capital.The RAROC instrument enables a proper balance to be
struck between risk, returns and capital for both the Group and its
constituent parts.This approach encourages the individual entities
to limit risks wherever possible and to ensure appropriate compen
sation, properly commensurate with the actual exposure. It is thus
an essential instrument for positioning products in the market at
the right price.
Besides the formulated strategy and the synergy to be achieved,
the RAROC of the activities concerned also plays a significant part
in the allocation of equity to the various Group entities and the
different risk categories. If the calculated RAROC lags behind the
formulated minimum result to be achieved, which is a reflection
of the costs of the capital employed, economic value is destroyed.
A higher RAROC implies the creation of economic value. RAROC is a
better measure of the performance of the Rabobank Group and its
entities than return on equity. It is our intention to publish informa
tion on this subject in the Annual Report for 2003. For the
Rabobank Group, prudent management of scarce capital is a logical
consequence of its co-operative mission.