If a bank has an estimated cost of equity capital of 12% (average ROE), and the bank allocates equity capital equal to 10% of its commercial loans value as a cushion against losses (i.e. equity to assets of 10%), and a marginal tax rate of 30%, what is the bank's capital charge after taxes and before tax RAROC capital charge?

Question

Quizplus · Accepted Answer

Capital Charge After Taxes = 12% ROE x .10 capital allocated = 1.20% 
 Before Tax Capital Charge 
= After tax Charge / (1 - t) = 1.2%/(1 - .30) = 1.71%

If a Bank Has an Estimated Cost of Equity Capital