Bank Capital Allocation and Performance Management under Multiple Capital Constraints

15 Pages Posted: 30 Nov 2017

Date Written: November 28, 2017

Abstract

To measure performance of individual businesses and maximize shareholder value for the firm as a whole, banks need to decide how much capital to allocate to each business and what cost of capital to charge. Capital is typically allocated to reflect differences in risks and/or regulatory capital requirements. The cost of capital has typically been set more judgmentally and often is not differentiated across business lines. We will motivate why we believe the focus needs to shift to the determination of the appropriate cost of capital. If the cost of capital accounts for differences in risk across business lines, the amount of allocated capital can be chosen more freely and naturally as a function of all competing regulatory and internal capital requirements. We describe how differentiation in the cost of capital can be achieved in a practical manner, and how a lack of differentiation leads to flawed pricing incentives and wrong conclusions about the contribution to shareholder value of individual business lines.

Keywords: Capital allocation, performance measurement, performance management, cost of capital, CAPM, regulatory capital, economic capital

JEL Classification: G20, G21, G32

Suggested Citation

Klaassen, Pieter and van Eeghen, Idzard, Bank Capital Allocation and Performance Management under Multiple Capital Constraints (November 28, 2017). Available at SSRN: https://ssrn.com/abstract=3079003 or http://dx.doi.org/10.2139/ssrn.3079003

Pieter Klaassen (Contact Author)

UBS AG ( email )

Postfach
Zurich, 8076
Switzerland

Idzard Van Eeghen

Royal Bank of Scotland (RBS) ( email )

135 Bishopsgate
London, EC2M 3UR
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
90
Abstract Views
416
rank
333,906
PlumX Metrics