1
V
RAROC: 13%
Credit risk
55 Rabobank Group Annual Report 2004
Organisation and risk management
Economic capital
Besides the supervisor's minimum capital adequacy requirements,
Rabobank applies an internal capital adequacy requirement, economic
capital. Economic capital is defined as the amount of capital to be
held by the bank to absorb any unexpected losses without becoming
insolvent, based on a one-year period and a confidence level set by
Rabobank. Since Rabobank Group wishes to retain its current highest
rating (AAA), it applies a confidence level of 99.99%. Rabobank Group
uses the most advanced statistical methods to determine the amount of
economic capital to be held. Clearly, Rabobank Group's capital is more
than sufficient to absorb unexpected losses. Rabobank Group sets these
high standards for itself because of the importance it attaches to retai
ning the highest possible credit rating (AAA). This rating implies that the
rating agencies consider the probability of default to be practically nil.
Risk plays an important part in the calculation of economic capital.
The better the diversification, the less economic capital is required, for
then there is a lower probability of the various losses occurring simul
taneously. Rabobank Group's total economic capital for 2004 has been
calculated at EUR 13 billion, slightly lower than in 2003. This level is
comfortably under that of the available Tier I capital (core capital) of
EUR 22.6 billion. This large capital buffer again confirms Rabobank
Group's solid position.
Allocation of economic capital
The concept of economic capital enables the bank to quantify, analyse
and subsequently manage the different risks that the bank is exposed
to. Proportionally, credit risk remains the largest risk category. A quarter
of the economic capital is designated for operational risks and business
risks. Interest rate risk arises due to the different maturities of assets and
liabilities on the balance sheet and the extent to which this risk
is hedged. Market risk arises from the trading portfolio and from
Interpolis' investment portfolio. The insurer's actual insurance risk is
considered separately. The capital to be held for operational risks has for
now been calculated using the standard approach of the Basel accord
(scaled up to AAA level). Business risk comprises the effects of changing
market conditions and reflects the tension between market dynamics
and the degree of flexibility of the cost structure for responding.
Breakdown of economic capital by risk
Credit risk
43%
Interest rate risk
17%
Business risk
14%
Operational risk
12%
Market risk
8%
Insurance risk
5%
Country risk
1%
Breakdown of economic capital by business unit
Retail banking
50%
Wholesale banking
27%
9
Participating interests
23%
Viewed by business unit, the retail banking operations account for half
of the economic capital required at Group level. It should be noted in
this context that the Group's interest rate risk position is managed cen
trally by the Treasury department, which forms part of retail banking.
Relating the profit realised on a particular activity to the capital required
for that activity produces the RAROC, the risk adjusted return on capital.
The RAROC (after tax) realised by Rabobank Group in 2004 was 13%.
This indicates that the Bank has largely fulfilled one of its core objectives:
the creation of economic value. Moreover, the RAROC ratio for the retail
operations and that for the wholesale banking operations and the total
of the participating interests show very little difference, which indicates
a balanced utilization of economic capital.
Rabobank pursues a prudent acceptation policy, characterised by careful
assessment of clients and their ability to make repayments. Rabobank
grants loans only if it expects that a client can fully meet its payment
commitments. Rabobank's portfolio is divided across a large number of
business sectors. This creates a large and balanced risk spread, so that
the quality of the financing portfolio does not significantly deteriorate if
one or more business sectors go through a difficult period or in the
event of an economic recession. Approval of larger financing applications
is decided on by various committees, the level of the applicable
committee depending on the amount of the requested financing.
The Executive Board itself decides on the largest financing applications.
