Kang, Woo-Young ORCID: https://orcid.org/0000-0001-6615-721X (2022) Internal capital budgeting and allocation in financial firms. In: Lee, Cheng-Few and Lee, Alice C., (eds.) Encyclopedia of Finance (3rd edition). Springer, Cham, Switzerland, pp. 2117-2137. ISBN 978-3030-912307 (doi:10.1007/978-3-030-91231-4_92)

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Abstract

Internal capital budgeting for financial firms differs from that for nonfinancial firms. Financial firms are highly leveraged, risk-sensitive, and possess limited equity capital to cover their illiquid risks compared to nonfinancial firms. Thus, some issues regarding internal capital budgeting – such as type of firm, financial shock, and capital budgeting methodologies – are somewhat different in case of financial and nonfinancial firms, while almost all their other characteristics including agency problem, optimal timing for capital budgeting, relative dependence on the external capital market, firm boundary, and market type remain near identical. Internal capital budgeting for financial firms aims to maximize their risk-adjusted performance measured by risk-adjusted return on capital (RAROC), return on risk-adjusted capital (RORAC), risk-adjusted return on risk-adjusted capital (RARORAC) and so on, leading to the maximization of shareholder value. On the other hand, internal capital budgeting for nonfinancial firms is largely affected by the traditional standard discounted cash flow (DCF) method. Financial firms are required to reflect regulatory capital requirements in their internal capital budgeting process, and using RORAC or RARORAC performance measures, which emphasize the risk component of capital, can be quite helpful for this.

Item Type:	Book Section
Uncontrolled Keywords:	internal capital market, external capital market, financial firms, nonfinancial firms, capital budgeting, economic capital, financial regulation
Subjects:	H Social Sciences > H Social Sciences (General) H Social Sciences > HF Commerce H Social Sciences > HF Commerce > HF5601 Accounting
Faculty / School / Research Centre / Research Group:	Greenwich Business School Greenwich Business School > School of Accounting, Finance and Economics
Last Modified:	16 Dec 2025 16:51
URI:	https://gala.gre.ac.uk/id/eprint/51989

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