Cognitive Scaffold

Preparing your thinking workspace

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MENTAL MODEL · M6807

RAROC

RAROC
BusinessHigh supportFinance
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Updated 2026-08-08

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INTRODUCTION

English translation pending.

CORE DEFINITION

RAROC, or Risk-Adjusted Return on Capital, links profit to the risk taken to earn it. Risk-adjusted earnings equal revenue minus expected loss, while economic capital is the buffer needed for unexpected loss, often estimated from value-at-risk models. Dividing the first by the second yields a ratio comparable across business lines, because a high-return, high-risk activity absorbs more capital than a low-risk one. Regulators and banks use it to allocate scarce capital to activities that generate the most return per unit of risk borne.

SCAFFOLDING EFFECT

psychology

Reduce cognitive load

- Use capital comparison: rank business lines by return earned per unit of risk taken. - Use pricing check: verify a loan rate covers its expected loss and capital charge. - Use allocation rule: shift capital toward the highest risk-adjusted returns available each quarter.

anchor

Anchor fast decisions

Return cannot be compared without risk. RAROC divides risk-adjusted earnings by economic capital, converting the tail risk each activity carries into a capital charge. That makes a high-return, high-risk line and a low-return, low-risk line directly comparable, so capital flows toward the activities with the best risk-adjusted return.

MINIMUM ACTION

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Source support: Explicit

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    en.wikipedia.orghttps://en.wikipedia.org/wiki/Risk-adjusted_return_on_capitalZH · Explicit
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