ROE hurdles cause pricing impasse
In the Basel III world, traders know their business must deliver a target return on equity, or risk being shut down – but working out the capital cost, or benefit, of a trade at inception is so difficult that banks only have approximations to guide them. For now, anyway. Laurie Carver reports
Capital is the great constraint on derivatives businesses these days, so it makes sense that their performance should be measured as the revenue bang for the regulatory buck – return on equity (ROE) under Basel III. That sounds simple enough, but while it's easy to set bank-wide or business-wide ROE hurdles, applying them on a trade-by-trade basis is creating a mind-boggling array of problems for pricing and organisation.
"Through the hurdle rates, capital is increasingly becoming the driver of
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