1. What does RAROC stand for in banking risk management?
A. Risk-Adjusted Rate of Capital
B. Return Against Risk of Capital
C. Risk-Adjusted Return on Capital
D. Revenue Allocation and Risk Oversight Capital
RAROC is the Risk-Adjusted Return on Capital, a performance measure that adjusts returns for the risk taken.
2. Which of the following is the primary objective of profit planning in banks?
A. Maximizing short-term deposits only
B. Forecasting income and expenses to achieve desired profitability
C. Reducing capital adequacy requirements
D. Ensuring only regulatory compliance
Profit planning helps banks forecast their income and expenses systematically to achieve targeted profitability.
3. How is RAROC generally calculated?
A. Risk-adjusted return divided by economic capital
B. Total deposits divided by total assets
C. Operating expenses divided by net interest income
D. Net profit multiplied by risk weight
RAROC is calculated by dividing the risk-adjusted return by the economic capital allocated to cover the risks.
4. Which of the following is a key component in bank profit planning?
A. Dividend payout ratio of other companies
B. Stock market index movements
C. Government budget deficit
D. Estimation of interest income and operating expenses
Profit planning focuses on projecting interest income, fee income, operating expenses, and provisions to achieve target profits.
5. Which statement best describes the relationship between RAROC and profit planning?
A. Profit planning ignores RAROC as it only considers budgeted profits
B. RAROC provides a risk-adjusted perspective which helps in more accurate profit planning
C. RAROC is used only for regulatory reporting, not planning
D. Profit planning and RAROC are unrelated concepts
RAROC allows banks to assess profitability after adjusting for risk, making profit planning more realistic and effective.
6. What is the main purpose of risk aggregation in banks?
A. To increase regulatory capital unnecessarily
B. To eliminate all operational risks
C. To combine different types of risks to assess total risk exposure
D. To focus solely on credit risk management
Risk aggregation helps banks combine credit, market, operational, and other risks to measure overall risk exposure effectively.
7. Capital allocation in banking refers to:
A. Assigning economic capital to different business units based on their risk profile
B. Distributing profits equally among shareholders
C. Allocating liquidity to branches for daily operations
D. Setting aside funds only for regulatory compliance
Capital allocation involves assigning economic capital to different business units or projects in proportion to the risk they take.
8. Which of the following is a key benefit of combining risk aggregation with capital allocation?
A. Reduces all market risks to zero
B. Ensures efficient use of capital while managing overall risk
C. Eliminates regulatory capital requirements
D. Focuses only on credit risk mitigation
By combining risk aggregation with capital allocation, banks can allocate capital efficiently across units while keeping total risk under control.
9. Economic capital in the context of capital allocation is defined as:
A. Total deposits held by the bank
B. Capital required to meet regulatory requirements only
C. Fixed asset investments of the bank
D. The amount of capital required to cover unexpected losses at a given confidence level
Economic capital is the capital that a bank must hold to cover unexpected losses, considering all types of risk, at a specific confidence level.
10. In risk-adjusted capital allocation, which metric is often used to compare business unit performance?
A. RAROC (Risk-Adjusted Return on Capital)
B. Total revenue of the bank
C. Regulatory capital ratio only
D. Loan-to-deposit ratio
RAROC is widely used to evaluate business unit performance by adjusting returns for the risks undertaken and the capital allocated.
11. Economic capital is primarily used in banks to:
A. Determine dividend payouts for shareholders
B. Cover unexpected losses at a specified confidence level
C. Fund branch expansion projects
D. Reduce operational costs
Economic capital is the capital required to absorb unexpected losses, ensuring the bank remains solvent under adverse conditions.
12. Which formula correctly represents RAROC?
A. Total Assets ÷ Equity
B. Net Profit ÷ Total Liabilities
C. Risk-Adjusted Return ÷ Economic Capital
D. Interest Income ÷ Operating Expenses
RAROC is calculated as the risk-adjusted return divided by the economic capital allocated to a business unit or project.
13. Which of the following is true regarding economic capital and regulatory capital?
A. Regulatory capital always exceeds economic capital
B. Economic capital is determined by RBI guidelines only
C. Both are always equal for all business units
D. Economic capital is internally calculated to cover risks, whereas regulatory capital is mandated by regulators
Economic capital is calculated internally based on a bank's risk profile, while regulatory capital is the minimum capital required by regulators.
14. A bank has a business unit with risk-adjusted return of ₹5 crore and allocated economic capital of ₹50 crore. What is the RAROC?
A. 5%
B. 10%
C. 15%
D. 20%
RAROC = Risk-Adjusted Return ÷ Economic Capital = 5 ÷ 50 = 0.10 or 10%.
15. Why is RAROC preferred over traditional return measures in banks?
A. It adjusts returns for risk, providing a more accurate performance measure
B. It ignores risk to focus on gross profits
C. It is simpler than ROA or ROE calculations
D. It is mandated by RBI for all transactions
RAROC adjusts returns for the level of risk taken, giving a clearer picture of risk-adjusted profitability compared to traditional metrics.
16. A bank has allocated ₹100 crore economic capital to its corporate loan portfolio. The expected profit after adjusting for credit and operational risk is ₹12 crore. What is the RAROC for this portfolio?
Which project should the bank prefer based on RAROC?
A. Both, as RAROC = 15% for each
B. Project X only, higher capital utilization
C. Project Y only, smaller capital commitment
D. Neither, both below minimum threshold
RAROC Project X = 18 ÷ 120 = 15%, RAROC Project Y = 12 ÷ 80 = 15%. Both have same RAROC; decision can be based on strategic priorities.
21. A bank is evaluating a retail loan of ₹50 crore. Expected profit after adjusting for credit and operational risk is ₹5 crore. The minimum RAROC required is 8%. Should the bank approve the loan?
A. No, RAROC = 10% & above minimum threshold
B. Yes, RAROC = 10% & above minimum threshold
C. No, profit is too low
D. Cannot decide without regulatory capital info
RAROC = 5 ÷ 50 = 10%, which exceeds the minimum required RAROC of 8%, so the loan can be approved.
22. If economic capital for the same loan increases to ₹60 crore due to higher risk, what is the new RAROC?
A. 12%
B. 8%
C. 8.33%
D. 6%
RAROC = Risk-adjusted return ÷ Economic capital = 5 ÷ 60 = 0.0833 or 8.33%.
23. A bank has two portfolios: Portfolio A (low risk, RAROC 9%) and Portfolio B (high risk, RAROC 14%). How can risk aggregation improve the bank’s overall performance?
A. By eliminating high-risk portfolio completely
B. By combining portfolios to balance total risk and maximize risk-adjusted returns
C. By reducing capital allocation to both portfolios equally
D. By ignoring RAROC and focusing on absolute profit
Risk aggregation allows the bank to combine low and high-risk portfolios to diversify risk, potentially improving overall RAROC.
24. A bank can fund either Project P or Project Q:
Project P: Capital ₹80 crore, expected risk-adjusted return ₹12 crore
Project Q: Capital ₹50 crore, expected risk-adjusted return ₹8 crore
Which project has higher RAROC?
A. Project P (15%)
B. Project Q (16%)
C. Project Q (16%)
D. Project P and Q have same RAROC
Project P: 12 ÷ 80 = 15%, Project Q: 8 ÷ 50 = 16%. Project Q has higher RAROC and is more efficient per unit of capital.
25. A bank has total economic capital of ₹200 crore. Units X, Y, and Z have allocated capital of ₹100, ₹60, and ₹40 crore respectively. Unit X RAROC = 12%, Y = 10%, Z = 8%. How should capital be reallocated to maximize overall RAROC?
A. Increase capital to Unit Z
B. Increase capital to Unit X and reduce capital from Unit Z
C. Keep allocation same
D. Reduce capital from Unit X to fund Unit Y
Units with higher RAROC (Unit X) should get more capital while reducing allocation from low RAROC units (Unit Z) to maximize overall risk-adjusted return.
