Business and Personal Finance Dictionary

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• RISK-ADJUSTED RETURN ON CAPITAL (RAROC)
  
  An economic approach to measure unit and product profitability within a financial institution. Returns, adjusted to reflect normalized or expected losses, are divided by an amount of capital that is carefully quantified to reflect the risk or risks incurred to generate those returns. The total risk-adjusted capital for an entire financial institution reflects its calculated economic capital. Economic capital is the capital required to support the incurred risks. Economic capital will rarely, if ever, equal accounting or book-value capital. The risk-adjusted return on capital is usually compared to a standard or hurdle rate of return. When such comparisons are made, products or units with returns exceeding the hurdle rate are said to add value while products or units with returns below the hurdle rate are said to destroy value. RAROC is not always defined and applied exactly the same way by different financial institutions but must be defined and applied consistently throughout each financial institution that uses it. Often referred to by the acronym RAROC, pronounced "ray-rock."
  
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