Inventory financing under <scp>Risk‐Adjusted‐Return‐On‐Capital</scp> criterion

Risk-Adjusted-Return-On-Capital (RAROC) is a loan-pricing criterion under which bank sets the loan term such that certain rate of return achieved on regulatory capital required by Basel regulation. Some banks calculate amount for each standardized approach (“standardized banks,” proportional to amount), and others internal rating-based (IRB) (“IRB related Value-at-Risk loan). This article examines impact RAROC bank's decision retailer's inventory decision. We find among terms satisfy criterion, one benefits retailer most requires specify an advance in addition interest rate. Under this term, level more sensitive his asset when facing IRB compared bank. An (standardized) leads higher profit retailers with high (low) asset. For medium asset, results but lower consumer welfare. Calibrated numerical study reveals benefit choosing (relative banks) can be as 30% industries severe constraints, volatile demands, low margins, highlighting importance carefully choose type borrow from. When capped regulation, borrowing from are likely influenced cap than those strong empire-building incentives (the will offer maximize size loan), initial shift their preference banks.