I've read that RAROC is used to set economic capital requirements for different products, projects, business lines etc.

Is it just a matter of solving for the required economic capital level to obtain a desired risk adjusted return on capital with a given risk adjusted return or is there more to it?

$RAROC = \frac{Risk\ adjusted \ return}{Economic\ Capital}$

  • 1
    $\begingroup$ Its a glorified sharpe ratio...the hard part is determining the parameters of the equation. Marginal EC is not easy to estimate. $\endgroup$
    – user9403
    Oct 21, 2015 at 19:22

1 Answer 1


Raroc is a risk based profitability measure. As you pointed out the connection to Basel is the use of the Capital.

As far as I know, in many banks it is used for steering of the yearly capital allocation. However, I believe that in the near future(see Basel 4) it will become more important to directly steer with economic capital.


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