FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

Economic Value Added and Shareholder Value in Banks

Updated 11 October 2026 · Fact-checked

Economic value added (EVA) is the profit a business line earns after charging for the capital it uses. EVA = risk-adjusted profit − (cost of capital × economic capital). A positive EVA means value is created for shareholders. Compare RAROC with the hurdle rate to reach the same conclusion.

Understand Economic Value Added and Shareholder Value

A business line can show an accounting profit and still destroy value. Shareholders supply capital and expect a return for the risk they bear. If profit is below that required return, the line is not paying for its capital.

Economic value added (EVA) turns this into a rupee, dollar or euro amount. You take the profit after expected losses and costs. Then you subtract a capital charge: the cost of capital multiplied by the capital the unit uses. In banks, the capital is usually economic capital, the capital needed to cover unexpected loss at a chosen confidence level.

RAROC (risk-adjusted return on capital) gives the same idea as a ratio: risk-adjusted profit ÷ economic capital. You compare RAROC with the hurdle rate, which is the cost of equity or required return on capital. RAROC above the hurdle means value creation. RAROC below it means value destruction.

The two measures always agree on the sign. If RAROC > hurdle, EVA > 0. They differ in what they show. RAROC is a percentage and ignores size. EVA is an amount and rewards scale. A small unit with a high RAROC can add less EVA than a large unit with a modest but positive spread.

The quality of the answer depends on the inputs. The capital allocation method, the confidence level and the cost of capital all change the result. Diversification benefits and the treatment of expected loss also matter. The exam tests whether you can use the numbers and read the result correctly.

Key formulas to remember

Risk-adjusted profit: Risk-adjusted profit = Revenue − Costs − Expected loss (+ return on allocated capital, if the bank credits it); Expected loss is deducted from profit. Capital covers unexpected loss. Follow the question's definition of profit.
RAROC: RAROC = Risk-adjusted profit ÷ Economic capital; Compare with the hurdle rate. Some versions add the return on capital to profit. Use the data given.
EVA: EVA = Risk-adjusted profit − (Cost of capital × Economic capital); Positive EVA means value created. Uses the same profit and capital as RAROC.
EVA from RAROC: EVA = (RAROC − Hurdle rate) × Economic capital; Valid when RAROC and the hurdle rate use the same profit and capital definitions.
Value-creation rule: RAROC > Hurdle rate ⇔ EVA > 0; The two tests give the same verdict for a given unit and capital base.

How to solve Economic Value Added and Shareholder Value questions

Use this order for any EVA or RAROC question. Read the definitions in the stem before you calculate.

1Identify what the question asks: EVA amount, RAROC ratio, or a value-creation judgement.
2Find the risk-adjusted profit. Start from revenue, subtract costs, then subtract expected loss. Check whether taxes or a return on capital are included.
3Find the capital base. Use economic capital unless the stem says otherwise. Note the confidence level and any diversification.
4Find the cost of capital or hurdle rate. Match it to the capital base used.
5Calculate RAROC = profit ÷ capital, or EVA = profit − (rate × capital).
6Compare to the benchmark. RAROC above the hurdle or EVA above zero means value is created.
7If several units are compared, rank by EVA for absolute value added and note that RAROC ignores size.
8Check the units and sign, then pick the option that matches your result and interpretation.

Quickest way: EVA spread shortcut

When to use it: Use it when the stem gives RAROC, the hurdle rate and capital, or asks which unit adds most value.

Compute the spread: RAROC − hurdle rate.
Multiply the spread by economic capital to get EVA.
A negative spread gives negative EVA straight away. You can eliminate options on sign alone.
To rank units, compare spread × capital, not RAROC alone.

Common mistakes in Economic Value Added and Shareholder Value

Deducting economic capital instead of the capital charge when computing EVA.
Students confuse the capital amount with its cost.
Fix: Subtract only cost of capital × capital. Capital itself is not an expense.
Ignoring expected loss in risk-adjusted profit.
Revenue less costs looks like profit, so the loss provision is forgotten.
Fix: Always deduct expected loss first. Capital covers unexpected loss, not expected loss.
Ranking business lines by RAROC alone.
A higher percentage looks better.
Fix: RAROC ignores size. Rank value added by EVA, and use RAROC to judge efficiency of capital.
Using regulatory capital with a hurdle rate meant for economic capital, or the reverse.
Both are called capital and the stem may mention both.
Fix: Use the capital measure the stem names for the calculation and keep the hurdle rate consistent with it.
Concluding that positive accounting profit means value creation.
Accounting profit does not charge for equity capital.
Fix: Value is created only when profit exceeds the capital charge, so EVA > 0 or RAROC > hurdle.
Treating the RAROC and EVA verdicts as able to conflict.
Students see a ratio and an amount and assume they measure different things.
Fix: With the same inputs, both signal value creation together. They differ only in scale and presentation.

Worked examples

Example 1

A corporate lending unit has revenue of $90 million, operating costs of $40 million and expected loss of $20 million. Economic capital is $150 million. The cost of capital is 12%. Calculate RAROC and EVA, and state whether the unit creates value.

Show the solution

Risk-adjusted profit = 90 − 40 − 20 = $30 million.
RAROC = 30 ÷ 150 = 20%.
Capital charge = 12% × 150 = $18 million.
EVA = 30 − 18 = $12 million.
Check: (20% − 12%) × 150 = $12 million. It matches.

Answer: RAROC is 20% and EVA is +$12 million. RAROC exceeds the 12% hurdle, so the unit creates value.

Example 2

Unit A has economic capital of €400 million and RAROC of 14%. Unit B has economic capital of €100 million and RAROC of 22%. The hurdle rate is 12% for both. Which unit adds more EVA, and by how much?

Show the solution

Unit A spread = 14% − 12% = 2%. EVA = 2% × 400 = €8 million.
Unit B spread = 22% − 12% = 10%. EVA = 10% × 100 = €10 million.
Compare: €10 million is greater than €8 million.
Both are positive, so both create value. B adds more here despite its smaller capital.

Answer: Unit B adds more EVA: €10 million against €8 million for Unit A, a difference of €2 million.

Exam tips

Write the formula first, then fill in numbers. Most traps sit in the profit definition.
Check whether expected loss is already deducted in the stem before you subtract it again.
When a question compares RAROC with a hurdle rate, think EVA sign. It speeds elimination of options.
Read interpretation options carefully. Both measures depend on the capital allocation and confidence level chosen.
Watch for size: a higher RAROC does not mean a higher EVA.

Practice questions from Risk Capital Attribution and Risk-Adjusted Performance Measurement

Economic Value Added and Shareholder Value in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Economic Value Added and Shareholder Value: frequently asked questions

What is the difference between EVA and RAROC?

EVA is an amount: risk-adjusted profit minus a charge for capital. RAROC is a ratio: risk-adjusted profit divided by economic capital. With the same inputs, both give the same verdict on value creation.

How do I use RAROC for performance evaluation in FRM Part II?

Compute RAROC for each unit and compare it with the hurdle rate. Units above the hurdle create value. Then use EVA to see how much value in absolute terms, since RAROC ignores size.

Which cost of capital is used in the EVA formula for banks?

Use the rate given in the question, usually the cost of equity or required return on capital. It must match the capital base you apply it to.

Why is expected loss deducted from profit but not from capital?

Expected loss is a normal cost of doing business and is priced or provisioned. Economic capital covers unexpected loss, the deviation above the expected level.