Cost Of Risk Formula For Banks

Cost of Risk Formula:

\[ COR = \frac{\text{Expected Losses}}{\text{Total Assets}} \times 100 \]

Cost of Risk (COR):

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1. What is the Cost of Risk Formula?

The Cost of Risk (COR) formula measures banking risk cost as the percentage of expected credit losses relative to total assets. It's a key metric for assessing a bank's credit risk exposure and provisioning adequacy.

2. How Does the Calculator Work?

The calculator uses the Cost of Risk formula:

\[ COR = \frac{\text{Expected Losses}}{\text{Total Assets}} \times 100 \]

Where:

\( COR \) — Cost of Risk (%)
\( \text{Expected Losses} \) — Anticipated credit losses (USD)
\( \text{Total Assets} \) — Bank's total asset base (USD)

Explanation: The formula expresses expected credit losses as a percentage of the bank's total asset portfolio, providing a standardized measure of risk cost across different sized institutions.

3. Importance of Cost of Risk Calculation

Details: COR is crucial for banks to assess credit risk exposure, determine adequate loan loss provisions, comply with regulatory requirements (Basel III), and make informed lending and risk management decisions.

4. Using the Calculator

Tips: Enter expected losses and total assets in USD. Both values must be positive, with total assets greater than zero for valid calculation.

5. Frequently Asked Questions (FAQ)

Q1: What is considered a good Cost of Risk ratio?
A: Lower COR indicates better risk management. Typically below 0.5% is considered good, but varies by bank size, portfolio composition, and economic conditions.

Q2: How does COR differ from loan loss provisions?
A: COR is a ratio expressing risk cost as percentage of assets, while loan loss provisions are the actual amounts set aside to cover expected credit losses.

Q3: What factors influence a bank's Cost of Risk?
A: Economic conditions, credit portfolio quality, lending standards, collateral values, industry concentrations, and macroeconomic factors.

Q4: How often should COR be calculated?
A: Typically calculated quarterly for regulatory reporting and internal risk management, with annual comprehensive reviews.

Q5: Can COR be negative?
A: No, COR cannot be negative as it represents expected losses. However, it can be zero if no losses are anticipated.