Telecom, Energy & Utilities

As a global leader in providing credit-decisioning information, analytical tools and marketing services to organizations and consumers, Experian is no stranger to telecommunications or to TRMA. In fact, the current TRMA home page reflects this connection, listing Experian as TRMA’s 2009 Best In Class Affiliate Award recipient and leader atop the Fall, 2010 Affiliate scorecard. Finding treasure in Vegas More importantly, however, the page reminds visitors that TRMA’s primary goal is “reducing fraud and uncollectibles in the telecom industry.” Toward that end, they’ve put together a dynamic, information-rich conference for February 22-23 entitled “Sailing towards Treasured Results.” This year, several Experian executives – including myself – will have the privilege of contributing knowledge and expertise to the proceedings. Get connected before, during and after TRMA In these days before the event, I’ll virtually introduce you to each of Experian’s TRMA speakers and give you the opportunity to learn more about them and their topics. During the conference, as time permits, some will be tweeting and blogging their thoughts, opinions and observations. They’ll analyze and unpack conference developments, and share their analysis with our followers and readers. Stop wondering, start following We expect a lot of actionable information from TRMA. So if you aren’t following us on Twitter (@experiancredit) or checking this site regularly, before, during or after the event would be the ideal time to start. You’ll gain a lot of insights from people who really understand telecom’s unique credit challenges and opportunities. And if you're attending TRMA, I certainly hope to see you there.

I love a good analogy, and living in Southern California, lately I’ve been thinking a lot about earthquakes, and how lenders might want to start thinking like seismologists when considering the risk levels in their portfolios. Currently, scientists that study earthquakes review mountains of data around fault movement, tidal forces, even animal behavior, all in an attempt to find a concrete predictor of ‘the big one’. Small tremors are inputs, but the focus is on predicting and preparing for the large shock and impact of large earthquakes. Credit risk modeling, conversely, seems to focus on predicting the tremors, (risk scores that predict the risk of individual default) and less so the large-shock risk to the portfolio. So what are lenders doing to forecast ‘the big one’?  Lenders are building sophisticated models that contemplate the likelihood of the big event – developing risk models and econometric models that look at loan repayment, house prices, unemployment rates – all in an attempt to be ahead of the credit version of ‘the big one’.  This type of model and perspective is at a nascent stage for many lenders, but like the issues facing the people of Southern California, preparing for the big-one is an essential part of every lender’s planning in today’s economy.

TRMA’s Spring Conference scheduled for February 22-23, 2011 As you probably already know, the mission of the Telecommunications Risk Management Association (TRMA) is to “drive positive change in order to reduce fraud and optimize risk for the benefit of the industry, individual members and paying customers.” As part of that mission, TRMA is committed to bringing together risk management professionals several times a year for information-sharing forums. The organization’s 2011 Spring Conference is scheduled for February 22-23, 2011 at the Treasure Island Hotel & Casino in Las Vegas. Experian representation at the TRMA Conference At Experian, we’re committed to investing in new technologies in order to offer our communications customers the most advanced fraud prevention and risk management tools. Being a part of TRMA helps us better understand how we can best respond to existing and emerging requirements to one of the key industries we serve. And it allows us to share what we see as up-and-coming trends as well as new developments in risk management. Experian Decision Analytics personnel are scheduled to present at TRMA’s 2011 Spring Conference, as follows: Jim Nowell, Business Consultant TRMA Learning Lab – The SimTel Business Game Tuesday, February 22, 8:00 a.m. – 12:00 p.m. Jim’s lively Learning Lab will have several small teams of risk managers working together to solve problems for a fictitious Telco portfolio. The results of the game will be delivered on Wednesday morning at 10:45 AM.   Linda Haran, Senior Director, Strategy and Marketing Economic Update Wednesday, February 23, 9:30 – 10:30 a.m.   Linda serves as one-half of this panel, reviewing the historical linkages between credit conditions and the economy with an emphasis on how they relate to telecommunications.   Greg Carmean, Program Manager, Small Business Credit Share Small Business Panel Wednesday, February 23, 11:15 a.m. – 12:15 p.m.   Greg serves as one-half of this panel, discussing best practices for small business risk assessment, such as employing a blend of consumer and commercial data to combat fraud.   Jeff Bernstein, Executive Strategic Consultant Leveraging Technology to Maximize Returns on Outsourced Collections Wednesday, February 23, 2:00 – 2:45 p.m.   Jeff serves as one-half of this panel, discussing ways to avoid the “perfect storm” of rising delinquency rates, lower liquidation and staff drowning in the tidal wave of bad debt. We hope to see you there More details on each of these presentations will follow this post in the coming week. We look forward to seeing you at TRMA’s Spring Conference. If you can’t attend (or even if you can), be sure to follow us on Twitter for live conference updates, and check back here for post-conference blog posts.

For companies that regularly extend credit, the need to establish an identity theft protection program is finally here. After almost two years of delay, the Red Flags Rule is now in force. For readers of the Experian Decision Analytics blog, the Rule has been a familiar topic since passage. If you want to skip ahead to find out what you need to know, we’ve made it easy by boiling it down to three main things. (You’ll find the “3 Things Telcos Should Know About the Rule” towards the end.) However, some background might be helpful to better understand the issues behind the delay. Discussion about Red Flags requirements first began when Congress passed the Fair and Accurate Credit Transactions Act in 2003, requiring the Federal Trade Commission to write and enforce the Rule as the nation’s consumer protection agency. The Red Flags Rule was actually enacted on Jan 1, 2008, but enforcement was delayed until December 31, 2010 to better clarify the terms of compliance and who had to follow them. Why the Red Flags Rule matters A “red flag” is something that signals possible identity theft, including any suspicious activity suggesting crooks might be using stolen information to establish service. The regulation now requires companies to develop a written “red flags program” to detect, prevent and minimize damage that could result from a security breach. Establishing a Red Flags program Companies that regularly extend credit or use consumer reports in connection with a credit transaction need to have a risk-based security program in place. The program must detail the process for detecting red flags, describe how to respond to prevent and mitigate identity theft, and spell out how to keep the program current.   Decision to delay: the definition of “creditor” At the center of the FTC’s decision to delay enforcement was a broad definition Congress gave to the term “creditor.” The Rule broadly captured a number of non-financial companies (many of them small businesses) that didn’t know whether it applied to them, and if they did, didn’t have time or expertise to establish proper procedures to comply. And failure to comply could lead to costly fines or civil actions. New Red Flags exemptions To resolve the issue, Congress approved legislation providing exemptions for businesses that provide goods or services and then accept payment later. The bill redefines the term “creditor” to apply only to businesses that advance funds to, or on behalf of a customer, based upon an obligation to repay. 3 things telcos should know about the Red Flags Rule: 1. Telcos are covered by the Rule For companies, like telcos, that obtain consumer reports, directly or indirectly, in connection with a credit transaction the requirement to comply hasn’t changed. In fact, under regulatory guidance, the FTC specifically lists telecommunications companies among those who need to comply. 2. Your company needs a written Red Flags program The FTC Rule requires that organizations identify and address the “red flags” that could indicate identity theft and update the program periodically. The program must address certain “covered accounts,” which includes a consumer account with frequent transactions or those that have a risk of identity theft.  An annual report must also be created for senior management or the board of directors.   3. How to comply is up to you The good news is that the Rule doesn't require any specific practice or procedures. Companies have the flexibility to tailor compliance programs to the nature of their business and the risks they face. The FTC will assess compliance based upon whether a company is taking “reasonable policies and procedures” to prevent identity theft.    

The passage of the Telecommunications Act of 1996 increased competition in the telecom industry. These days, nearly every telecommunications company is offering, or considering offering, bundled services to attract new customers, increase retention of current customers, or both. Every time I turn around, there seems to be a new variety of bundled services. Quality, ease of use, and the right price points in a market, make these bundles very attractive to consumers. Most offers are directed at consumers, but the industry is looking for emerging market spaces. AT&T just announced it would be offering its U-verse IPTV product and its via-resale DirecTV service, bundled together with landline voice, wireless voice and broadband Internet services, to the small business market. The company explained this package might be attractive for small businesses with client waiting rooms. Bundle of joy While there are a few risks involved in offering bundled services (a topic we will explore in a future post), by and large, the benefits of bundled services are many: 1. Enhanced customer loyalty - Customers are less likely to go to the trouble of unbundling services in order to switch providers. - Customers feel more connected to your organization on multiple fronts. (Both of these help to shield you from competitive displacement attempts.)   2. Simplified customer experience - Consumers enjoy the convenience of bundled services, which allows them to manage multiple services with a single billing statement and a single payment. - When money is tight, bundle customers will generally pay the entire bill, as opposed to paying only part of the bill.     3. Save provider time and money - Bundled billing reduces the number of bills sent each billing cycle, which means less paperwork for you and your customers. - Fewer bills sent also means fewer payments to process.     4. Penetrate new markets - Partnering with a company, who has a bigger footprint in a particular market, allows you to leverage that partner’s existing customer base. - Bundling also can help you penetrate a new market with more competitive price points.     5. Easier and less risky up-selling path for larger share of consumer products and services - The partner, already having an established relationship with the consumer, will have an easier time up selling your product offerings to their customer base.     If you’re thinking about getting into the bundling game — or expanding on your current bundling strategy — you need to know that getting bundling right is no easy task. Check back for future blog posts in which I’ll discuss what makes a “smart” bundled offering, as well as how to ensure you’re offering the right bundle to the right customers. In the meantime, if there are specific topics in the realm of bundling you would like to see addressed, please be sure to comment on this post.

Remember the new customers or subscribers you brought on last year, and how great they looked on paper?  High credit score, low revolving debt—clean as a whistle, solid as a rock. How do those stellar profiles look right now, in 2011? Still solid? Or has their luster recently faded? In today’s uncertain environment, it’s both a legitimate and prudent question credit departments should often ask. Regular portfolio reviews: illuminate, eliminate Because of the financial relationship between your company and its customers, you have a right to make “soft” inquiries to uncover new credit-quality risk. Red Flag indicators include a recent bankruptcy, an increase in late payments, and other credit obligations staying past due longer. Whatever the changes are, you’re entitled to know them, and regular portfolio reviews are an effective way to illuminate (and eliminate) risk. The other side of the coin Thankfully, telecom/cable credit trends are not all gloom and doom. Many people have actually improved their scores and are good candidates for better terms, better rates and cross-sell opportunities that can increase your wallet share. Of course, once you land good customers, keeping them happy becomes paramount. Increasing the number of products or services they use can make customers “stickier” and more loyal. So if, as mentioned in my previous post, acquisition is about prospect quality (not quantity), then retention and risk reduction are about regular portfolio reviews and keeping people happy. Supplementing reviews by letting customers know you value and appreciate their business, will help them stay put when pesky competitors come knocking.

Experian Decision Analytics has recorded increased demand from the marketplace for service integrations with interactive voice response (IVR), a phone technology that allows for automated detection of both voice and touch–tones. In the past quarter, there has been a more than 70 percent increase in IVR interest and it continues to grow. Why is there a demand for knowledge based authentication through IVR? Besides consumer acceptance of out of wallet questions, there is a dramatic increase in the need for remote authentication and fraud analytics that are accurate, not a burden to the consumer, cost–effective for organizations and part of an overall risk based authentication approach. Consumers stay connected in a number of ways — phone, online, mobile and short message service (SMS) — and are demanding the means to remain safe without compromising convenience. Knowledge based authentication through IVR provides this safety. Organizations must consider all the tools at their disposal to keep consumer data protected while preserving and promoting a positive customer experience. Given the interactive nature of knowledge based authentication, it is quite adaptable to various customer access channels, such as IVR, and it enables full automation of both inbound and outbound authentication calls. We know from both our own experience and from working with clients that consumers are more connected, more mobile and more networked than ever before - and fraud trends demonstrate this increases risk. As consumers continue to expand online profiles and fraud artists continue to seek out victims, successful fraud prevention will become paramount to financial survival. Leveraging products already in use by combining the technology capitalizes on an existing investment and is good business.

Cybersecurity is back in the news, thanks in no small part to a number of government reports and developments with WikiLeaks. It’s also becoming increasingly important to businesses and lawmakers alike. Although not a new concern for the telecommunications industry, cybersecurity is quickly becoming a priority for the new Congress as pressure increases to develop a national plan. What should cybersecurity protect? A national cybersecurity plan would likely entail setting baseline security standards to protect critical networks – many of which are run by private organizations. For policymakers, the challenge will be to craft guidelines that protect consumer data and still allowing technological innovation. Last year, we saw a number of legislative proposals debated before Congress that would place new requirements on network infrastructure and strengthen coordination between federal regulators. So far, the proposals have been broad and have only raised additional questions. The hurdle for lawmakers will be addressing how existing data protection laws fit within new proposals in order that businesses do not face over burdensome requirements. Where does the FCC fit in? When it comes to cybersecurity, the role of the FCC is even more undefined – however that’s changing. Last summer, the FCC asked for public comments about the creation of a Cybersecurity Roadmap to identify vulnerabilities to communications networks and to develop countermeasures and solutions to cyber threats. The roadmap was first recommended as part of a broader strategy to create a National Broadband Plan that required the FCC to identify the five most critical security threats and establish a two-year plan to address them. While the Commission has accepted public comments, it’s unclear when a final Roadmap will be introduced. A national breach notification standard As part of a comprehensive plan, policymakers are also looking at what happens after a breach occurs. Currently, 46 states have passed laws requiring companies to notify consumers after a security breach. As a result, policymakers have begun to examine whether a national data breach law is necessary given the varying degrees of consumer notification. The FCC has indicated their support of a uniform law and has recommended that Congress include telecoms in the legislative discussion. Despite the uncertainty, one thing is sure: cybersecurity will be increasingly important to monitor during 2011. One way to stay current is to subscribe via email or RSS as we continue to look at the latest legislative or regulatory developments concerning the wireless and telecommunications industry. In the near future, we’ll be taking a look at recent data privacy recommendations by federal regulators and the privacy agenda of the new Congress. Meanwhile, if you’d like more information on Data Breach Notification or Fraud Management Compliance, your Experian representative can help. Let us know your concerns regarding cybersecurity and pending legislative issues so that we can address them in future posts.

In the communications industry, effective acquisition is a multi-step process, best begun by asking (and accurately answering) simple, but critical questions: Who are our best prospects? Where can we find them? What should we offer them and how? Of course, the “why” is obvious—beating competitors to the punch. The similarities of today’s increasingly undifferentiated products and services make attracting high-quality customers more critical than ever. On the surface, the “who” seems equally straightforward. But it’s surprising how many communications companies still blanket the nation with ads and offers without knowing whom they want to reach or which messages to lead with. This brings us to the “how” of effective acquisition. Banks get it right Banks provide a good acquisition model. In these days of tight budgets and high expectations, most would never dream of investing in a campaign without first creating a well-defined, data-driven segmentation strategy. To get the results they want, institutions usually establish some credit-score threshold, check past payment history and assess other factors and behaviors, before starting up their marketing machine. Not surprisingly, the rewards for this foresight often include higher response rates, lower costs and greater value per promotional dollar. What’s next? Once you zero in on a fresh crop of qualified prospects the “whats” come next: what’s the best marketing channel? What products or services should we offer? What terms? Again, clean historic data, combined with up-to-date information from surveys and questionnaires can reveal surprising insights into why customers choose your company or offer over your competitors’. In communications, as in banking, reliable data is a proven source for answers to a whole slew of customer-acquisition questions. But does it offer similar value in other phases of customer lifecycle management? And if so, how? Funny you should ask. Because that’s exactly what future posts here will cover, so please check back often.

Cell phone use on the rise A Wikipedia list of cell phone usage by country showed that as of December 2009, the U.S. had nearly 286 million cell phones in use. In parallel, a recent National Center for Health Statistics study found that one in every seven homes surveyed received all or almost all their calls on cell phones, even though they had a landline. Study results further indicated, one in four homes in the U.S. relied solely on cell phones. This statistic highlights these households had no land line at all during the last half of 2009. Since this time, the number of households that fall within this category have increased 1.8 percent. Implications for communications companies The increasing use of cell phones, coupled with the decreasing use of landlines, raises some very important concerns for communications companies: The physical address on file may not be accurate, since consumers can keep the same number as they jump providers. The increased use of pre-paid cell phones shines a new light on the growing issue that contact numbers are not a consistent means of reaching the consumer. These two issues make locating cell phone-only customers for purposes of cross-selling and/or collections an enormous challenge. It would certainly make everyone’s job easier if cell phone providers were willing to share their customer data with a directory assistance provider. The problem is, doing so, exposes them to attacks from their competition and since provider churn rate concerns are at an all-time high, can you really blame them? Identifying potentially risky customers, among cell phone-only consumers, becomes more difficult. Perfectly good customers may no longer use a landline. From a marketing point of view, calling cell phones for a sales pitch is not allowed, how then do you reach your prospects?     What concerns you? Certainly, this list is by no means complete. The concerns above warrant further discussion in future blog posts. I want to know what concerns you most when it comes to the rise in cell phone-only consumers. This feedback will allow me to gear future posts to better address your concerns.

By: Kari Michel Credit bureau data has been used for many years to develop credit risk models, bankruptcy scores,  profitability models, and response models to name a few. For the utility industry (water and power companies), a new score is available to help them administer more efficiently their internal low-income assistance programs. One challenge that utility companies face is to identify those consumers who clearly qualify for low-income assistance in a more automated process in order to reduce the number of applications that require manual intervention. Utility companies are starting to use scoring models to help them determine the likelihood that a customer will qualify for low-income assistance from their local utility. In a recent Experian case study, a medium-sized municipal utility company in California conducted a test using Experian’s Financial Assistance Checker to understand the benefit of using this score in their recertification process. The test showed a reduction of manual review of about 40% of the test file and they expect a 40-50% reduction in manual review in the future. The inclusion of the score in the recertification process will reduce costs and make their low income assistance program more efficient and provide an excellent example of the utility’s efforts to make a positive impact on the community.

Quite a scary new (although in some ways old) form of identity theft in the headlines recently. Here’s a link to the article, which talks about how children’s dormant Social Security numbers are being found and sold by companies online under the guise of CPN’s – aka credit profile numbers or credit protection numbers.  Using deceased, “found”, or otherwise illicitly obtained Social Security numbers is not something new.  Experian’s and any good identity verification tool is going to check against the Social Security Administration’s list of numbers listed as deceased as well as check to ensure the submitted number is in an SSA valid issue range.  But the two things I find most troubling here are: One, the sellers have found a way around the law by not calling them Social Security numbers and calling them CPN’s instead.  That seems ludicrous!  But, in fact, the article goes on to state that “Because the numbers exist in a legal gray area, federal investigators have not figured out a way to prosecute the people involved”. Two, because of the anonymity and the ability to quickly set up and abandon “shop”, the online marketplace is the perfect venue for both buyer and seller to connect with minimal risk of being caught. What can we as consumers and businesses take away from this?  As consumers, we’re reminded to be ever vigilant about the disclosure of not only OUR Social Security number but that of our family members as well.  For businesses, it’s a reminder to take advantage of additional identity verification and fraud prediction tools, such as Experian’s Precise ID, Knowledge IQ, and BizID, when making credit decisions or opening accounts rather than relying solely on consumer credit scores.

To calculate the expected business benefits of making an improvement to your decisioning strategies, you must first identify and prioritize the key metrics you are trying to positively impact.  For example, if one of your key business objectives is improved enterprise risk management, then some of the key metrics you seek to impact, in order to effectively address changes in credit score trends, could include reducing net credit losses through improved credit risk modeling and scorecard monitoring. Assessing credit risk is a key element of enterprise risk management and can addressed as part of your application risk management processes as well as other decisioning strategies that are applied at different points in the customer lifecycle. In working with our clients, Experian has identified 15 key metrics that can be positively impacted through optimizing decisions.  As you review the list of metrics below, you should identify those metrics that are most important to your organization. • Approval rates • Booking or activation rates • Revenue • Customer net present value • 30/60/90-day delinquencies • Average charge-off amount • Average recovery amount • Manual review rates • Annual application volume • Charge-offs (bad debt & fraud) • Avg. cost per dollar collected • Average amount collected • Annual recoveries • Regulatory compliance • Churn or attrition Based on Experian’s extensive experience working with clients around the world to achieve positive business results through optimizing decisions, you can expect between a 10 percent and 15 percent improvement in any of these metrics through the improved use of data, analytics and decision management software. The initial high-level business benefit calculation, therefore, is quite important and straightforward.  As an example, assume your current approval rate for vehicle loans is 65 percent, the average value of an approved application is $200 and your volume is 75,000 applications per year.  Keeping all else equal, a 10 percent improvement in your approval rates (from 65 percent to 72 percent) would generate $10.7 million in incremental business value each year ($200 x 75,000 x .65 x 1.1).  To prioritize your business improvement efforts, you’ll want to calculate expected business benefits across a number of key metrics and then focus on those that will deliver the greatest value to your organization.  

By: Wendy Greenawalt Given the current volatile market conditions and rising unemployment rates, no industry is immune from delinquent accounts. However, recent reports have shown a shift in consumer trends and attitudes related to cellular phones. For many consumers, a cell phone is an essential tool for business and personal use, and staying connected is a very high priority. Given this, many consumers pay their cellular bill before other obligations, even if facing a poor bank credit risk. Even with this trend, cellular providers are not immune from delinquent accounts and determining the right course of action to take to improve collection rates. By applying optimization, technology for account collection decisions, cellular providers can ensure that all variables are considered given the multiple contact options available. Unlike other types of services, cellular providers have numerous options available in an attempt to collect on outstanding accounts.  This, however, poses other challenges because collectors must determine the ideal method and timing to attempt to collect while retaining the consumers that will be profitable in the long term.  Optimizing decisions can consider all contact methods such as text, inbound/outbound calls, disconnect, service limitation, timing and diversion of calls.  At the same time, providers are considering constraints such as likelihood of curing, historical consumer behavior, such as credit score trends, and resource costs/limitations.  Since the cellular industry is one of the most competitive businesses, it is imperative that it takes advantage of every tool that can improve optimizing decisions to drive revenue and retention.  An optimized strategy tree can be easily implemented into current collection processes and provide significant improvement over current processes.

By: Tom Hannagan Understanding RORAC and RAROC I was hoping someone would ask about these risk management terms…and someone did. The obvious answer is that the “A” and the “O” are reversed. But, there’s more to it than that. First, let’s see how the acronyms were derived. RORAC is Return on Risk-Adjusted Capital. RAROC is Risk-Adjusted Return on Capital. Both of these five-letter abbreviations are a step up from ROE. This is natural, I suppose, since ROE, meaning Return on Equity of course, is merely a three-letter profitability ratio. A serious breakthrough in risk management and profit performance measurement will have to move up to at least six initials in its abbreviation. Nonetheless, ROE is the jumping-off point towards both RORAC and RAROC. ROE is generally Net Income divided by Equity, and ROE has many advantages over Return on Assets (ROA), which is Net Income divided by Average Assets. I promise, really, no more new acronyms in this post. The calculations themselves are pretty easy. ROA tends to tell us how effectively an organization is generating general ledger earnings on its base of assets.  This used to be the most popular way of comparing banks to each other and for banks to monitor their own performance from period to period. Many bank executives in the U.S. still prefer to use ROA, although this tends to be those at smaller banks. ROE tends to tell us how effectively an organization is taking advantage of its base of equity, or risk-based capital. This has gained in popularity for several reasons and has become the preferred measure at medium and larger U.S. banks, and all international banks. One huge reason for the growing popularity of ROE is simply that it is not asset-dependent. ROE can be applied to any line of business or any product. You must have “assets” for ROA, since one cannot divide by zero. Hopefully your Equity account is always greater than zero. If not, well, lets just say it’s too late to read about this general topic. The flexibility of basing profitability measurement on contribution to Equity allows banks with differing asset structures to be compared to each other.  This also may apply even for banks to be compared to other types of businesses. The asset-independency of ROE can also allow a bank to compare internal product lines to each other. Perhaps most importantly, this permits looking at the comparative profitability of lines of business that are almost complete opposites, like lending versus deposit services. This includes risk-based pricing considerations. This would be difficult, if even possible, using ROA. ROE also tells us how effectively a bank (or any business) is using shareholders equity. Many observers prefer ROE, since equity represents the owners’ interest in the business. As we have all learned anew in the past two years, their equity investment is fully at-risk. Equity holders are paid last, compared to other sources of funds supporting the bank. Shareholders are the last in line if the going gets rough. So, equity capital tends to be the most expensive source of funds, carrying the largest risk premium of all funding options. Its successful deployment is critical to the profit performance, even the survival, of the bank. Indeed, capital deployment, or allocation, is the most important executive decision facing the leadership of any organization. So, why bother with RORAC or RAROC? In short, it is to take risks more fully into the process of risk management within the institution. ROA and ROE are somewhat risk-adjusted, but only on a point-in-time basis and only to the extent risks are already mitigated in the net interest margin and other general ledger numbers. The Net Income figure is risk-adjusted for mitigated (hedged) interest rate risk, for mitigated operational risk (insurance expenses) and for the expected risk within the cost of credit (loan loss provision). The big risk management elements missing in general ledger-based numbers include: market risk embedded in the balance sheet and not mitigated, credit risk costs associated with an economic downturn, unmitigated operational risk, and essentially all of the strategic risk (or business risk) associated with being a banking entity. Most of these risks are summed into a lump called Unexpected Loss (UL). Okay, so I fibbed about no more new acronyms. UL is covered by the Equity account, or the solvency of the bank becomes an issue. RORAC is Net Income divided by Allocated Capital. RORAC doesn’t add much risk-adjustment to the numerator, general ledger Net Income, but it can take into account the risk of unexpected loss. It does this, by moving beyond just book or average Equity, by allocating capital, or equity, differentially to various lines of business and even specific products and clients. This, in turn, makes it possible to move towards risk-based pricing at the relationship management level as well as portfolio risk management.  This equity, or capital, allocation should be based on the relative risk of unexpected loss for the different product groups. So, it’s a big step in the right direction if you want a profitability metric that goes beyond ROE in addressing risk. And, many of us do. RAROC is Risk-Adjusted Net Income divided by Allocated Capital. RAROC does add risk-adjustment to the numerator, general ledger Net Income, by taking into account the unmitigated market risk embedded in an asset or liability. RAROC, like RORAC, also takes into account the risk of unexpected loss by allocating capital, or equity, differentially to various lines of business and even specific products and clients. So, RAROC risk-adjusts both the Net Income in the numerator AND the allocated Equity in the denominator. It is a fully risk-adjusted metric or ratio of profitability and is an ultimate goal of modern risk management. So, RORAC is a big step in the right direction and RAROC would be the full step in management of risk. RORAC can be a useful step towards RAROC. RAROC takes ROE to a fully risk-adjusted metric that can be used at the entity level.  This  can also be broken down for any and all lines of business within the organization. Thence, it can be further broken down to the product level, the client relationship level, and summarized by lender portfolio or various market segments. This kind of measurement is invaluable for a highly leveraged business that is built on managing risk successfully as much as it is on operational or marketing prowess.