Bank Capital Budgeting

Introduction
Capital budgeting plays an important role in allocating resources in enterprises. Through a well-structured process of capital budgeting done by individual divisions, an enterprise can compare the profitability of its divisions, assess the feasibility of new business proposals, decide which projects to expand, construct a corporate portfolio to maximize returns, such as ROA, ROE and RAROC (risk-adjusted return of capital), and minimize risk.


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Traditional metrics for capital budgeting include NPV, IRR, payback period, ROI and etc. However, these metrics may provide misleading conclusions for banks[1]. Their biases tend to more severe after the implementation of Basel II, which links bank capital charges with market risk, credit risk and operational risk.
This paper aims to discuss the limitations of traditional metrics for bank capital budgeting and suggest a new framework of capital budgeting for banks to comply with Basel II. The new framework is able to accommodate a wide range of risk measures, consider capital charges required, evaluate funding costs and compare risk-adjusted values of individual divisions and projects. This paper finally discusses how this new framework can be applied to non-bank enterprises in order to enhance their value-based management