Loan Pricing Of Main Industries Based On The Raroc Model

As a major source of revenue and the primary carrier of China’s social financing, Loan transaction is not only the basis for the commercial banks to survive, but also very important to our country’s economical development. So the reasonable pricing of the loan, is not only related to the size of the bank’s own profit, but also involves the smooth transition of China’s real economy.However, due to the long-term control of interest rate, the loan pricing ability of China’s commercial banks is generally weak, with the full loan pricing release to the financial institutions in July,2013, China’s commercial banks can independently carry out differentiated pricing strategy in accordance with the risk factors and the relation of market supply and demand,but it’s also no small challenge to the ability of risk control and pricing of commercial banks.Meanwhile, with the increasing sophistication of China’s capital market and acceleration of the marketization of interest rates in recent years," financial disintermediation " phenomenon has intensified greatly and commercial banks have to face the short-term decrease of spreads. In addition, the emerging Internet-based financial services has a direct impact on commercial banks, making it face increasing pressure from the rising cost of capital and intensified interest rate risks, furthermore, with the formal implementation of China’s new banking capital management approach, commercial banks face more stringent requirements of capital wider risk coverage.Therefore, under the State of Flux, only by enhancing the ability of risk management and loan pricing can commercial banks maintain a dominant position in the increasingly fierce competition.RAROC is a comprehensive loan pricing method which measures the real profitability of commercial banks,it has got more and more attention and application in China’s commercial banks in recent years, As a long-term loan pricing mechanism assuring income cover the total risks and costs, it relies on the effective risk management tool-economic capital, to create an efficient capital constraints and loan pricing mechanism,it combines risk management and value creation by taking the return on shareholders’minimum capital requirements as a clear objective in the business running. This paper discusses the application of RAROC model in the best economic capital allocation and loan pricing of commercial banks.In the empirical analysis, this paper selects the loan balance of the top10industries with more proportion in CCB balance sheet of the year2013as study objects. According to previous methods,we calculate the economic capital (EC)of these industries to quantify the risk level and theoretically get their bottom loan prices that meet the minimum return requirement of CCB’s shareholders.In order to forecast the optimal EC amount in2014,we introduce the concept of potential RAROC level,which measures the potential performance of these10industries to CCB, then we use linear programming to get the accurate economic capital allocation results and thus achieve a reasonable forecast of the new loan price with other factors being stable.After that,combined with that formerly got loan price of2013,we analyze the loan pricing efficiency on general and part perspectives.Empirical evidence shows that in2013, the average RAROC level of the top ten industry loans of CCB is24.95%, and in the seven industries above the average, Water conservancy、environment and public facilities management industry is the highest, reaching126.19%, followed by mining and construction, reaching72.25%and55.75%respectively, indicating the potential of high capital efficiency and strong risk control ability. Judging from the intuitive point of view, in order to give full play to their ability to contribute to the loan portfolio, in2014CCB should increase their capital allocation according to their different potential RAROC levels, and for the manufacturing, transportation and information industries which are below the average RAROC level, their capital allocation should be reduced advisably.Further empirical research found that the capital allocation results obtained from the optimal economic capital allocation model with the objective of maximizing EVA are basically consistent with the previous intuitive judgment. And the loan price based on this optimal allocation sees wider price range and more flexibility. According to the empirical results, the average interest rate of the ten industries based on RAROC Model is little above8%, about35%higher than the benchmark rate, and except the Electricity heat&water Supply and Water conservancy、 environment and public facilities Management, the loan price of the remaining eight industries were all higher than central bank’s one-year benchmark rate, with information transmission&software&IT service getting the highest lending rate, followed by leasing and business services, also nearly twice of the benchmark rate.This shows that a simple fluctuation referring to the central bank benchmark interest rates may underestimate the loan risk in certain industries, resulting in a lack of compensation for the unexpected losses.by comparison, using RAROC model through a comprehensive quantitative analysis of various cost and risk elements, to determine the price of the industry loans,can not only help improve the accuracy of loan pricing, but also provide a more rational basis for banks when the relevant departments carrying out refined management and performance assessment of loans.This paper argues that, in the actual implementation of RAROC loan pricing, based on the theoretical guidance, banks should also make modest adjustments under the national macro-control policies and also combined with the bank’s own situation.Last of all, through an overview of practical problems in carrying out the RAROC loan pricing method, this paper ends in corresponding recommendations to improve the RAROC loan pricing model.