Internal models

There will be a close correlation between economic capital, used for internal performance management, and regulatory capital when CRD is fully implemented in 2010. This implies refinements to Danske Bank's performance management. After a transition period ending in 2010, performance evaluation and management will be based exclusively on a new risk management concept, called Return on Allocated Capital (ROAC) and total value creation.

Risk-adjusted return on economic capital - RAROC
Since 1999, the Group's RAROC-based risk management and reporting system has been a important element of its capital and financial management.

In its preparations for the CRD, the Group has benefited greatly from its experience with the RAROC method.

In 2006, the Group’s RAROC model was expanded to include concentration and diversification risk. As a result, RAROC will be replaced by a new risk management model, ROAC (Return on Allocated Capital) when the CRD takes effect.

The risk-adjusted return differs from the accounting return insofar as it reflects the average annual loss the Group expects to suffer over a business cycle. The method entails calculating the economic capital needed to absorb the variation in actual losses in relation to expected losses (also known as "unexpected losses"). The parameters used in the model are reviewed on an ongoing basis in relation to loss levels observed in the credit portfolio.

When the transition period ends in 2010, Danske Bank’s income assessment and management will be based exclusively on ROAC and overall value creation.

Concentration on few customers, industries and countries will increase the economic capital required and thus lower performance. Diversification will have the opposite effect because a diversified portefolio lowers risk.

Under ROAC, the entire capital will be allocated to the various business units. Consequently, there will be no unallocated capital at consolidated level. The intention is to build much closer correlation between risk and capital dedicated to cover that risk.

The following table shows the most important differences between RAROC, ROAC and Return on Equity (ROE).

	ROE	RAROC	ROAC
Framework	Regulatory	Internal	Internal
Time horizon	Point-in-time	1 year	3-5 years
Confidence level	NA	99.97%	99.97%
Concentration risk	No	No	Yes
Migration risk	No	No	Yes
Operational risk	No	Standard	Standard
Market risk	Advanced	Advanced	Advanced
Credit risk	Simple	IRB A	IRB A
Performance capital	All capital	Risk capital	All capital

The introduction of ROAC
ROAC will be fully implemented in 2010. The table below gives an overview of the transition period:

Year	Model
	ROE	ROAC
2007-2009	X	X
2010		X

Back to top


Last updated/revised on January 31, 2008