Managing Bank Capital: Capital Allocation and Performance Measurement, 2nd Edition

18

Practical Issues in Implementation

Many, if not all, of the models described in this book are either derived directly from the internal management accounts (requiring a stream of revenues, contributions etc. over a series of periods from which to calculate the volatility) or require management accounting numbers (such as “return”) in order to derive an RoC measure. This chapter is dedicated to three technical issues which are likely to be encountered when building these management accounts: differences between mark-to-market and accruals accounting, funds transfer pricing, and a particular trap which can be encountered when using a net-present-value accounting approach in conjunction with an RoC model.

Cost allocation is also an issue in management accounts, but whilst this may affect the definition of “return” in any RoC, RAROC or RORAC calculation, it is unlikely to have any significant impact on the definition of “capital” or the measurement of risk, as costs are typically not very volatile in the short term. The topic of appropriate cost allocation techniques is therefore left to other textbooks: the focus here is on the attribution of revenue to particular periods and to individual businesses. It is emphasised that without a robust method for attributing revenues to businesses it is probably not worthwhile attempting to build any capital allocation model at all; indeed, building a decent series of management accounts is the necessary precursor to any capital allocation ...