AA-rated bank estimates its losses of 1% of outstanding loans on average per year. The 99.9% worst-case loss if 5% of outstanding loans. Its spread between the cost of funds and the interest charged is 2.5%. You are given sufficient information to find Risk-Adjusted Return on Capital. a. True b. False

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Business

Stephen Buck

25 December, 19:20

AA-rated bank estimates its losses of 1% of outstanding loans on average per year. The 99.9% worst-case loss if 5% of outstanding loans. Its spread between the cost of funds and the interest charged is 2.5%. You are given sufficient information to find Risk-Adjusted Return on Capital. a. True b. False

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Marc · Answer 1

Answer: False

Explanation:

The Risk adjusted Return on capital is used by banks to know the level of risk the bank may fall into based on the loan they give out to the borrowers of the loan. The bank is expected to engage in responsible risk management. The formula for calculating the risk adjusted return on capital is

Cost - Expected losses + income from capital / Economic or total capital

In this question we are given the interest charged to be 2.5%, we are given the expected losses to 1% based on industry average. But we are not given the actual figure of the loan lent out, in which to calculate the 5% of the loan which is still outstanding, and we are not given the income from the capital. We are not given the cost of the fund. Therefore, we are not given sufficient information to find Risk - Adjusted Return on capital.