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Pitfalls in the application of RAROC, with reference to loan management

Author: Dermine, Jean INSEAD Area: Finance Series: Working Paper ; 95/58/FIN Publisher: Fontainebleau : INSEAD, 1995.Language: EnglishDescription: 14 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: The purpose of the paper is to discuss four pitfalls commonly found in the application of RAROC to loan management. These are, respectively, the use of a single hurdle rate, the timing of profit recognition, the time horizon for equity allocation, and the under-identified benefits of portfolio diversification. Without explicit recognition of these pitfalls by senior bank management, the application of RAROC to risk-adjusted performance measurement can lead to misleading information
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The purpose of the paper is to discuss four pitfalls commonly found in the application of RAROC to loan management. These are, respectively, the use of a single hurdle rate, the timing of profit recognition, the time horizon for equity allocation, and the under-identified benefits of portfolio diversification. Without explicit recognition of these pitfalls by senior bank management, the application of RAROC to risk-adjusted performance measurement can lead to misleading information

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