1
Allocation
RAROC: 12%
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54 Rabobank Group Annual Report 2003
Divided according to risk category, half the economic capital covers the
credit risk (including country risk).This risk category is the most important
one in several respects. Not only does an advanced system analyse the
capital requirement, but it also enables better and more efficient risk
assessment, provides insight into the degree of risk diversification and
is an excellent pricing instrument for loans granted. A quarter of the
economic capital is designated for the operational risk and the business
risk.The capital for operational risk has been calculated on the basis of
the standards of the Basel proposals, but Rabobank Group is working on
an advanced model based on both internal and external data.The
business risk reflects the tension between the large market dynamics
and the degree of flexibility in the response. Of the remaining part,
around 20% covers the interest rate risk that arises due to the various
terms of assets and liabilities on the balance sheet and the degree to
which this risk is hedged.The market risk of the trading portfolio also
plays a part in this. A small part (5%) of the economic capital is required
for the insurance risk.
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 Rabobank Group and the group entities.
This approach encourages the individual entities to use capital as
efficiently as possible and to ensure appropriate compensation, properly
commensurate with the actual exposure. It is thus an essential instrument
for positioning products in the market at the right price. Beginning with
the budget process for the year 2005, Rabobank Group intends for both
the realised and the expected RAROC of the various activities to play a
significant role in the allocation of economic capital. RAROC is a better
measure of the performance of the Group and its entities than return on
equity. In 2003, return on available capital was 9.4% and the calculated
return on economic capital (RAROC) after tax was 12%. This is clearly
more than the cost of the capital employed, indicating that the Bank has
fulfilled one of its core purposes to a significant degree: the creation of
economic value.
Economic capital allocation by risk category
Economic capital allocation by Group entities
Credit risk
50%
Retail banking 48%
Operational and business risk
25%
Wholesale banking 28%
Market risk and interest rate mismatch
20%
Other 24%
Insurance risk
5%
