EVA and RAROC in Banking Performance Metrics

For efficient business strategy and to improve performance, many financial institutions, such as B. Banks, bank performance metrics. These metrics help measure business unit profitability, manage risks associated with capital allocation, and evaluate each business unit’s performance.

The increasing diffusion of technology and the complexity of the market are driving many institutions to improve their performance. In a competitive world, survival is a goal of many companies, both new and advanced, while those at the top also strive to maintain their glory.

Success in a highly competitive environment then became a challenge for companies. To achieve this, companies like banks need to measure their performance in order to be able to find solutions when the result of the measure appears unfavourable. Bank performance metrics can be used to help managers make complex decisions.

Among the key performance indicators used by many banks and other companies when preparing financial information for decision making and evaluation are Economic Value Added and Risk-Adjusted Return on Investment, or RAROC.

Economic Value Added, known simply as the acronym version, is an estimate of a company’s real economic profit after making corrective adjustments to generally accepted accounting principles or GAAP accounting, including the deduction of the opportunity cost of equity. It has been estimated that companies’ use of GAAP ignores a certain proportion of opportunity costs to shareholders.

A company’s EVA can be measured by subtracting the cash cost of capital from the after-tax net operating income. The money cost of capital in EVA refers to the amount of money instead of the cost of capital in proportional proportion.

Stern Stewart & Co. develops its registered trademark, Economic Value Added Performance Metrics.

Meanwhile, the RAROC, or risk-adjusted return on investment, is used to analyze a company’s risk-adjusted financial performance and provide an overview of profitability. It is a risk-based framework for measuring profitability.

A ratio of risk-adjusted return to economic capital, RAROC, is used to determine a firm’s economic return. This system is used to allocate capital for risk management and performance evaluation.

The risk-adjusted return on investment is used by banks and other financial institutions. As a risk management tool, RAROC is used to determine the bank’s optimal capital structure by allocating capital to individual business units.

In addition, RAROC is used as a bank performance metric to allow banks to allocate capital to companies and business units, which is determined based on each unit’s economic value added or EVA. Risk-based capital utilization improves banks’ capital allocation. A return is expected from the capital at risk that exceeds the risk-free return.

EVA and RAROC are among the banking performance metrics used by banking business entities to determine profitability in an economic sense. The economic added value is used in corporate financing to determine the value that is created beyond the required return. On the other hand, the risk-adjusted return on capital is determined for capital allocation for the purpose of risk management and performance evaluation.