Risk-weighted asset (also referred to as RWA) is a bank's

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

s or

off-balance-sheet In accounting, "off-balance-sheet" (OBS), or incognito leverage, usually describes an asset, debt, or financing activity not on the company's balance sheet. Total return swaps are an example of an off-balance-sheet item. Some companies may have ...

exposures, weighted according to

risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environ ...

. This sort of asset calculation is used in determining the capital requirement or

Capital Adequacy Ratio Capital Adequacy Ratio (CAR) also known as Capital to Risk (Weighted) Assets Ratio (CRAR), is the ratio of a bank's capital to its risk. National regulators track a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies ...

(CAR) for a financial institution. In the

Basel I Basel I is the first Basel Accord. It arose from deliberations by central bankers from major countries during the late 1970s and 1980s. In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of minimu ...

accord published by the

Basel Committee on Banking Supervision The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten (G10) countries in 1974. The committee expanded its membership in 2009 a ...

, the Committee explains why using a risk-weight approach is the preferred methodology which banks should adopt for capital calculation: *it provides an easier approach to compare banks across different geographies *off-balance-sheet exposures can be easily included in capital adequacy calculations *banks are not deterred from carrying low risk liquid assets in their books Usually, different classes of assets have different risk weights associated with them. The calculation of risk weights is dependent on whether the bank has adopted the

standardized Standardization (American English) or standardisation (British English) is the process of implementing and developing technical standards based on the consensus of different parties that include firms, users, interest groups, standards organiza ...

or IRB approach under the

Basel II Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. It is now extended and partially superseded by Basel III. The Basel II Accord was publ ...

framework. Some assets, such as

debentures In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowle ...

, are assigned a higher risk than others, such as cash or government

securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...

/ bonds. Since different types of assets have different

profiles, weighting assets according to their level of risk primarily adjusts for assets that are less risky by allowing banks to discount lower-risk assets. In the most basic application, government debt is allowed a 0% "risk weighting" - that is, they are subtracted from total assets for purposes of calculating the CAR. A document was written in 1988 by the

which recommends certain standards and regulations for banks. This was called

, and the Committee came out with a revised framework known as

. The main recommendation of this document is that banks should hold enough capital to equal at least 8% of its risk-weighted assets. More recently, the committee has published another revised framework known as

Basel III Basel III is the third of three Basel Accords, a framework that sets international standards and minimums for bank capital requirements, Stress test (financial), stress tests, liquidity regulations, and Leverage (finance), leverage, with the goa ...

. The calculation of the amount of risk-weighted assets depends on which revision of the Basel Accord is being followed by the financial institution. Most countries have implemented some version of this regulation.

Example

For an example of how risk-weighted assets are calculated and derivation of capital ratio, see Reserve Bank of New Zealand:Capital adequacy ratios for banks
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References

Bank regulation Financial risk Credit risk Capital requirement Management cybernetics

Example

See also

References