Commercial Loan Pricing Calculator (RAROC)
Build up a loan's full economics — cost of funds, expected loss, operating cost, capital allocation, taxes — and see whether the proposed rate clears your RAROC target.
Inputs
Loan terms
Cost components
Capital & taxes
RAROC clears the 15% target with a working margin.
Definition
How commercial loan pricing works
A commercial loan rate isn't picked from a sheet — it's built up from four economic components: cost of funds, expected credit loss, operating cost, and required return on the capital allocated against the loan. Each component is a real cash cost or required return that the loan must cover to create economic value for the bank.
RAROC = (NIM + amortized fees − expected loss − operating cost) × (1 − tax) ÷ Allocated capital. Most banks target a RAROC of 12% to 18%. A loan priced below the target either gets repriced, restructured, or declined.
Pricing discipline is one of the most important — and most under-instrumented — parts of community and regional bank credit. A 25 basis-point pricing miss on a $5 million loan is roughly $90,000 of lost economic value over five years, after tax.
Components
What goes into a commercial loan rate
Cost of funds
The weighted-average cost of deposits and wholesale funding used to fund the loan. Floor for any loan rate — pricing below cost of funds is an immediate negative spread.
Expected loss
Modeled annual credit cost: Probability of Default × Loss Given Default × Exposure at Default. Strong C&I credits run 20–40 bps; weaker credits 100–200 bps.
Operating cost
Origination, underwriting, servicing, and overhead allocated to the loan. Typically 40–80 bps for community-bank commercial loans.
Capital allocation
Capital held against the loan (regulatory or economic). Most commercial loans attract a 100% risk weight at roughly 8–12% of principal.
Tax rate
Federal and state tax shield applied to pre-tax spread before computing return on capital. Use the bank's marginal effective rate.
Target return on capital
The bank's minimum after-tax return on allocated capital. Most community and regional banks target 12–18%; specialty and larger banks 15–25%.
Worked Example
Pricing a $2M C&I term loan
A community bank is pricing a $2,000,000, 5-year C&I term loan at 7.50% with a 0.50% origination fee. Cost of funds is 4.00%. Expected loss on this risk grade is 40 bps; operating cost is 60 bps. Capital allocation is 10%, tax rate 25%, target RAROC 15%.
Gross yield = 7.50% + (0.50% / 5 yrs) = 7.60%.
NIM = 7.60% − 4.00% = 3.60%.
Net spread = 3.60% − 0.40% (EL) − 0.60% (ops) = 2.60%.
After-tax = 2.60% × (1 − 0.25) = 1.95% on principal.
After-tax dollars = $2,000,000 × 1.95% = $39,000.
Allocated capital = $2,000,000 × 10% = $200,000.
RAROC = $39,000 / $200,000 = 19.5% — clears the 15% target.
If cost of funds rose to 5.00%, RAROC would compress to about 11.6%. The loan would either need to be repriced ~50 bps higher, picked up with additional fees, or declined.
Questions & Answers
Loan pricing — frequently asked questions
What is RAROC?
RAROC stands for Risk-Adjusted Return on Capital. It measures the after-tax return a loan generates relative to the regulatory or economic capital allocated against it. RAROC = (Net interest margin + fees − operating cost − expected loss) × (1 − tax rate) ÷ Allocated capital. Most banks set a target RAROC (commonly 12% to 18%) that loans must clear to be approved at the proposed rate.
How do banks price commercial loans?
Commercial loan pricing builds up from cost of funds, then adds expected loss (the credit risk premium), operating cost (origination and servicing), and a target return on allocated capital. The sum is the minimum rate the loan must carry to clear the bank's hurdle. Anything above that rate creates economic profit; anything below destroys it.
What is expected loss in loan pricing?
Expected loss is the bank's modeled annual credit cost for a loan, calculated as Probability of Default (PD) × Loss Given Default (LGD) × Exposure at Default (EAD). For a strong-credit C&I loan it might be 20 to 40 basis points; for higher-risk credits or sectors, it can be 100 to 200 basis points. Expected loss is the long-run average loss the bank should expect to absorb in pricing.
What is cost of funds?
Cost of funds is the weighted-average rate the bank pays for the deposits and wholesale funding used to fund a loan. It blends checking and savings rates, CD rates, FHLB advances, and any subordinated debt or capital allocation. Cost of funds is the floor — a loan priced below cost of funds generates an immediate negative spread.
What is capital allocation in loan pricing?
Capital allocation is the share of the bank's regulatory or economic capital assigned to a specific loan. For risk-weighted regulatory capital, a typical commercial loan attracts a 100% risk weight, so $1M of loans requires roughly $80,000 to $120,000 of capital depending on the bank's leverage and capital ratios. RAROC measures return on this allocated capital.
How do fees affect loan pricing?
Origination fees, commitment fees, prepayment fees, and other non-interest income are typically amortized over the expected life of the loan and added to the effective yield. A 1% origination fee on a 5-year loan adds roughly 20 basis points of annualized yield. Fees can be the difference between a marginal and a cleared RAROC.
What is a typical RAROC target?
Most community and regional banks target a RAROC of 12% to 18%. Larger banks and specialty lenders may target 15% to 25% depending on their cost of equity. Below the target, the loan should be repriced, restructured, or declined; above the target, the loan creates economic value.
What is the difference between NIM and RAROC?
NIM (Net Interest Margin) is the difference between loan rate and cost of funds — a measure of gross spread. RAROC takes NIM further by subtracting expected loss and operating cost, applying taxes, and dividing by allocated capital. Two loans with the same NIM can have very different RAROCs depending on credit risk and capital usage.
Should community banks use RAROC?
Yes. RAROC isn't just for money-center banks — community banks increasingly use simplified RAROC frameworks to make sure relationship pricing covers the bank's full economic cost. The output supports loan committee discipline and helps justify pricing decisions to examiners and the board.
Related
Related calculators & resources
Borrower repayment capacity with stress testing.
Multi-entity, multi-guarantor cash flow rollup.
Property-level CRE metrics.
End-to-end automation for commercial credit.
Source-cited memos with full ratio analysis.
Compare platforms for spreading and analysis.
Aloan automates the analysis behind every priced loan
Spreading, ratio analysis, risk grading, and credit memo generation with full source citations — so loan committee can focus on pricing and structure, not data entry.