The loan pricing based on RAROC is a comprehensive risk pricing method. RAROC takes safety and profit as the goal of the banking business, matching the price and dynamic risk of the loans, reflecting different treatment between the difference of risk degree of loans. This is conducive to the optimization and the rationalization to risk of bank loans.
This paper focused on the improvements of RAROC Pricing and its application at our country’s commercial bank. In the western commercial bank loan pricing, RAROC in recent years has been widely adopted, it is a base Pricing methods in the economic capital and default rates. To the security of the banking business, the profitability target, considering the bank’s cost of capital, operating expenses, the expected loss and the risk premium.
Its advantages:Give full consideration to the different degree of risk of each loan business, loan pricing is closely related to their degree of risk,Loan pricing and risk match, reflecting the differential treatment of loans to customers of different risk levels,Certain extent to solve the single pricing conditions, adverse selection of loans to customers (adverse selection) problem, enabling Bank loan customers to optimize and rationalize the risk-Foreign RAROC theory is more focused on how Application of RAROC management of credit risk and economic capital in preparation.
2. literature review NealM. Stoughton and Josef Zechner insist the RAROC and EVA based on capital budgeting is the Foundation for financial institutions managing optimal capital configuration.
Under asymmetric information condition, for an Single-sector financial institutions existing outside management costs, they leads to an optimal capital configuration framework, the framework is applicable to multi-sectoral financial investment diversification Institutions, they believe that all financial institutions have the cost of external management, the external tube Management costs increased the usage of limited economic capital of financial institutions, easily lead to excessive investment in risky projects. Indeed, when the necessary rate of return(hurdle rate) is Given, a single risk sector institutions should
consider the cost of debt of established on the basis of the required rate of return of capital, and there are multiple risk sectors financial institutions, the necessary rate of return should be consistent with the cost of equity capital. In International Monetary Research(2005) Liu yali, Deng Yunsheng, Ren ruoen write an article “RAROC model under the single economic capital estimation and simulation estimates of the lending “. Using ROROC mode,around the economic capital, calculation two Point of view from the theoretical estimates and simulation of economic capital.
Concretely two estimated calculation of economic capital with the situation:sub-model of default and mark to market model, stare in the study of thecity model loan in economic capital estimation problem, based on the Credit Metrics System, Monte Carlo simulation methods and optimization methods of Shape were studied, and the use of the existing experimental data were simulated . The test results show that the degree of single-business economic capital of the derivation,the amount of risk sensitivity, sensitive to risk capital depends on the loan principal amount, credit rating, default correlation coefficient risk factors.
The article is organised as follows:the first section the basic knowledge of RAROC model,the first section estimates of economic capital in RAROC model,mainlyestimates of economic capital for loans under the default model ,estimates of economic capital for loans under Mark To Market Model. Under the default model,,he use a multiplier factor to linked the end of the loan portfolio variance and the credit risk of the loan portfolio VaR .
Taking into account the end of the loan portfolio value distribution of non-normality (or the so called fat tail Phenomenon ),the multiplier factor of the loan portfolio variance and the credit risk of the loan portfolio VaR must be bigger than the one in Normal distribution. Liu xinjun introduced RAROC model and did a comprehensive analysis on main risk variables of the model. RAROC model is derived on the basis of loans’ pricing formula based on RAROC. Subsequent,he analyzed the cost of capital,which is very important in loan pricing based on RAROC,and found that the changes of cost of capital will cause RAROC greater changes.
So,bank loan pricing needs to determine the cost of funds rationally. Using their own liability costs based on the cost of capital, we neglected the external market environment. In this thesis, he introduce the market cost of funds to the loan pricing based on RAROC. Using Shibor as the benchmark interest rates in short-term and treasury yield curve to more than one year, we get the internal cost of capital curve. The use of market-based bank’s internal funds transfer pricing possesses more scientific in calculating the cost of capital. So he made a good cost analysis in loan pricing.
In general,the RAROC Pricing Model hasn’t considered the contribution of the bank’s customers, which neglect the relationship between banks and their customers. In this paper, we made a dynamic adjustment on the loan credit risk and customers return, a slightly-amending on Two aspects of income tax and risk factor, to improve the RAROC Pricing Model. Then,the loans’ Price changed as enterprises-borrowers’ default risk with more sensitivity, also ensure realizing the banks’ expected profits, meeting requirements of capital adequacy ratio,Consistenting with the Basel Protocol’s principles to the commercial banking supervision.
Use the improved RAROC method to price banks’ loans, comparative the results as follows: the RAROC models pricing for different clients credit rating loans can obviously reflect the differences of the loans’ Price;on high-level credit rating clients such as AA or above, benchmark interest rates plus or minus method prices higher than the RAROC Pricing Model;Low credit rating clients such as BBB-level or below, the benchmark interest rate plus or minus method prices lower than the RAROC Pricing Model. The unadjusted RAROC Pricing Model calculated a higher price than the Model after adjustment.
The general RAROC Pricing Model prices too high or too low, as the lack of a reasonable estimate of the risk,also can easily lead the bank losing important customers. The improved RAROC Pricing Model took the customer’s credit changes into account, which is helpful for clients to improve the solvency of the customer and to strengthen risk management. Because of giving full consideration to inter-bank business relationship, according to General Customers return for lending rates to make adjust also close the bank-enterprise relations.
Using the improved RAROC Pricing Model in our country, the Commercial Banks can enhance the pricing power and competitiveness, reduce domestic enterprises’ financing costs,enhance the enterprises’ credibility and visibility. So this paper possesses particularly active significance. 3. references  Neal. M, Stoughton, Josef Zechner. Optimal Capital Allocation Using RAROC and EVA. University of Vienna, 1999,(1):2-30  Liu yali, Deng Yunsheng, Ren ruoen RAROC model under the single economic capital estimation and simulation estimates of the lending,2004 Liu xinjun. RAROC-based commercial bank lending in China research,2009