Financial Risk Manager Part 2

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Explanation:

To calculate the after-tax Risk-Adjusted Return on Capital (RAROC), we need to determine the net income after tax and divide it by the Economic Capital.

Calculate Economic Capital (EC): EC = 5% of EUR 420 million = EUR 21 million
Calculate Pre-tax Income:

Interest Income: 6% of 420m = EUR 25.2 million
Cost of Funding: 0.5% of 420m = EUR 2.1 million
Expected Loss: 3% of 420m = EUR 12.6 million
Operational Costs: 1% of 420m = EUR 4.2 million
Transaction Costs: EUR 1 million
Return on Economic Capital: 2% of 21m = EUR 0.42 million

Total Pre-tax Income = Interest Income - Cost of Funding - Expected Loss - Operational Costs - Transaction Costs + Return on EC = 25.2 - 2.1 - 12.6 - 4.2 - 1.0 + 0.42 = EUR 5.72 million

Calculate After-tax Income: Taxes = 35% of 5.72 million = EUR 2.002 million After-tax Income = 5.72 million - 2.002 million = EUR 3.718 million
Calculate RAROC: RAROC = After-tax Income / Economic Capital = 3.718 million / 21 million = 0.1770 or 17.70%

The closest value is 18%.

Explanation:

To calculate the after-tax Risk-Adjusted Return on Capital (RAROC), we need to determine the net income after tax and divide it by the Economic Capital.

Calculate Economic Capital (EC): EC = 5% of EUR 420 million = EUR 21 million
Calculate Pre-tax Income:

Interest Income: 6% of 420m = EUR 25.2 million
Cost of Funding: 0.5% of 420m = EUR 2.1 million
Expected Loss: 3% of 420m = EUR 12.6 million
Operational Costs: 1% of 420m = EUR 4.2 million
Transaction Costs: EUR 1 million
Return on Economic Capital: 2% of 21m = EUR 0.42 million

Total Pre-tax Income = Interest Income - Cost of Funding - Expected Loss - Operational Costs - Transaction Costs + Return on EC = 25.2 - 2.1 - 12.6 - 4.2 - 1.0 + 0.42 = EUR 5.72 million

Calculate After-tax Income: Taxes = 35% of 5.72 million = EUR 2.002 million After-tax Income = 5.72 million - 2.002 million = EUR 3.718 million
Calculate RAROC: RAROC = After-tax Income / Economic Capital = 3.718 million / 21 million = 0.1770 or 17.70%

The closest value is 18%.

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24.7.3. A commercial bank is evaluating the potential financial impact of extending a 1-year loan of EUR 420 million. The terms and associated costs of this loan are as follows:

The loan will accrue interest at a rate of 6% per annum.

The bank’s cost of funding, i.e., the interest paid on deposits, is 0.5% per annum.

The bank anticipates an expected loss, due to non-payment or other factors, equivalent to 3% of the loan's face value.

Operational costs for managing the loan are projected to be 1% of its face value.

The economic capital, which is the reserve the bank must hold against the loan as a risk mitigation measure, is set at 5% of the loan amount.

The return on this economic capital before taxes is expected to be 2%.

The bank operates under a tax rate of 35%.

Transaction costs EUR 1m

To assess the financial viability of the loan, the bank will calculate the after-tax Risk-Adjusted Return on Capital (RAROC), which measures the return on risk-adjusted assets after accounting for taxes and potential losses. Based on the above, RAROC is closest to:

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Last updated: July 5, 2026 at 07:03

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