THE BUSINESS APPLICATION
Where and how to use it
Use it to compare product lines, portfolio segments and growth allocations. Start by agreeing how funding, expenses, losses and capital are measured; inconsistent denominators can make an attractive ranking meaningless.
One product has a higher interest margin but consumes more internal risk capital. A common return framework reveals whether the additional margin compensates for that additional capital use.
From evidence to a decision
- 01Net contributionAfter costs and expected loss
- 02Defined capitalUse a consistent allocation
- 03Comparable ratioAlign period and denominator
- 04Allocation discussionCompare opportunities and limits
DATA REQUIREMENTS
What records does it need?
These are the records your team would bring together for this analysis. The exact fields and history needed depend on your lending products, the question you want to answer and the period you want to assess.
| Record category | What it contains | Why the detail matters |
|---|---|---|
| Expected contribution | Income, funding costs, expenses and expected loss. | Use one consistent period and allocation basis. |
| Capital measure | Economic/internal or another explicitly defined capital allocation. | Do not mix different capital concepts. |
| Comparison policy | Horizon, hurdle assumptions and segment boundaries. | Record who chose the assumptions and their version. |
Past loan outcomes help assess how well an estimate reflects your borrowers. For a new decision, use only the information available at that time; later repayments help you review the result afterwards.
Understand data readiness →WHAT YOU RECEIVE
The output
Comparable return measures, contribution/capital breakdowns and sensitivity to the chosen capital basis.
WHAT TO WATCH
The limitations
A zero or negative capital denominator makes a simple ratio unsuitable. Forecast return is not realised return, and accounting profit can differ from economic contribution.
FOR RISK & ANALYTICAL SPECIALISTSHow the analysis works+
The modelling approach
An analytical return measure combines a consistent contribution calculation with an explicit capital allocation. Policy can compare the result with an internally chosen hurdle, but the hurdle is an assumption to review, not a universal fact.
What your risk team should review
Denominator validity, period alignment, loss treatment and consistency of capital allocation.
The right approach depends on your portfolio and available history. Review the fit to your borrowers, the reliability of the estimates and the effect of missing information before using the result in a lending decision.