Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

RAROC, EVA, economic profit

In Stage 3, we calculated the return on equity of e-Bank:

ROE = profit after tax/equity.

For simplicity, we can visualize profit after tax and equity as two pies (Figure 4.1).

Figure 4.1. Allocated profit after tax and allocated equity

The pies are divided into pieces which represent the allocated amount of profit or equity to a particular business unit. For instance, the profit after tax allocated to business A is 2, while the amount of equity allocated to business A is 10.

With these profit and equity allocations, we can compute the return on equity of a specific profit centre. Many banks call this return RAROC ...