Traditional measures of profitability like return on assets (ROA) do not provide insight into the deposit-gathering side of the business, let alone non-fund products such as insurance sales and brokerage services. Risk-Adjusted Return on Capital (RAROC) has become the industry standard for evaluating an institution with a diverse set of services.

While the allocation of capital in a profitability model should complement a risk management and capital adequacy framework, there is a noteworthy difference. Regulatory frameworks, such as those provided by the governing regulatory bodies, are primarily developed to measure the safety and soundness of an institution. While they are an excellent starting point, they might not fully reflect the economic value created (or destroyed) by organizational units, lines of business, product, officers, and customers.

Clients have the flexibility of performing their own risk assessment or using guidelines developed by TKG. We have performed a number of these assessments and can offer constructive suggestions to an institution just beginning the capital allocation process. In many cases, institutions do not consider allocating capital to lines of business such as deposit gathering. Given the need to evaluate business units independently, and the very real risks associated with those activities, this becomes necessary.

• Assignment of allocated capital adjusted for risk to organizational units, lines of business, branches, products, officers, and customer accounts.
• Calculation of Return on Equity at the product and account-level which feeds into your existing MCIF and/or CRM systems.
• Best practice Capital Allocation approach and methodology.

• Identify products and lines of business that enhance and create shareholder value from those that destroy shareholder value.
• Improve your overall return on equity by identifying which asset products and lines of business should receive more or less of the financial institutions limited supply of fund sources, either deposits, borrowings, and/or equity.