Risk-Adjusted Profitability Measures (RAPM) questions..
Not really a CFA topic i guess but this is the best forum i can find for me to ask question, so thanks a lot!
For anyone who studied about Financial Intermediation before. (Might wanna read my notes under each question first to understand my point of view)
With regards to commercial banks,
1. How does the risk-adjusted profitability (RAPM) measure help to aid the pricing of exposures for customers? Is risk-based pricing (RBP) linked to this pricing of exposure too?
Notes: I read Risk Management in Banking by Joel Bessis (2010) and got the concept that we should use RBP (because RAPM of each facility changes after entering the portfolio) on marginal risk contribution to find the All-In-Spread for the new transaction (which is the pricing of exposures for customer i guess?), so as to align the return of the new deal with the target RAPM of the portfolio. However when i ask my lecturer about the link, he told me that bank just set the Target RAPM of each deal (not inside portfolio yet) and calculated the pricing for customer needed to ensure appropriate return. But shouldn’t we be using RBP for the new deal to maintain the portfolio targeted return as RAPM for each deal changes before and after entering into the portfolio
2. How is capital allocation linked to RAPM application?
Notes: In the slides given by the same lecturer said that RAPM helps to allocate capital based on the risk-return profile of the bank’s business unit/product/customer but when i ask him how does RAPM linked to capital allocation and he said Banks will set aside a amount of capital for different product and we can calculate RAPM from there (Kind of totally different meaning from what he wrote in the slides which utterly confused me). From what i assumed is that the Bank will use RBP to calculate the pricing for customer first to maintain the target portfolio return and from there, the bank will calculate the RAPM of each facility (after entering the portfolio), which the bank’s management will then decide on how to allocate capital based on the RAPM (which is in line to what he wrote in the slides i guess?)
P.S. i didn’t question the answer given by the lecturer as he was always rushing off and out of reach once exiting the class.
Sorry for posting such a long message and thanks in advance if you have answer to my question. Please do correct my understanding/concept of the RAPM gotten from reading the book if i’m wrong.
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