Traditional financial metrics, like Return on Equity (ROE), can mislead corporate boards because they measure pure profitability without factoring in the underlying risk taken to achieve those returns. To solve this, mature organizations use Risk-Adjusted Performance Metrics.

To evaluate the true profitability of individual business lines, treasury teams use Risk-Adjusted Return on Capital (RAROC) and Return on Risk-Adjusted Capital (RORAC) models. The plain-text formulas are structured as follows:

RAROC = (Revenues - Operational Expenses - Expected Loss + Funding Credits) / Economic Capital

RORAC = Net Income / Risk Adjusted Capital Allocation

By enforcing a RAROC metric across all divisions, a corporate board can easily compare high-risk lending teams with low-risk wealth management groups, ensuring capital is allocated to the business units that generate the highest risk-adjusted value for shareholders.