Risk-weighted asset
Encyclopedia
Risk-weighted asset is a bank's asset
s or off-balance sheet exposures, weighted according to risk
. This sort of asset calculation is used in determining the capital requirement or Capital Adequacy Ratio
(CAR) for a financial institution. In the Basel I
accord published by the Basel Committee on Banking Supervision
, the Committee explains why using a risk-weight approach is the preferred methodology which banks should adopt for capital calculation.
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
or IRB
approach under the Basel II
framework.
Some assets, such as debentures, are assigned a higher risk than others, such as cash or government securities
/bonds
. Since different types of assets have different risk
profiles, weighing assets based on the level of risk associated with them 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 Basel Committee on Banking Supervision
which recommends certain standards and regulations for banks. This was called Basel I
, and the Committee came out with a revised framework known as Basel II
. More recently, the committee has published another revised framework known as Basel III
. The main recommendation of this document is that banks should hold enough capital to equal at least 8% of its risk-weighted assets. 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.
, see
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s or off-balance sheet exposures, weighted according to risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
. This sort of asset calculation is used in determining the capital requirement or Capital Adequacy Ratio
Capital adequacy ratio
Capital adequacy ratio , also called Capital to Risk Assets Ratio , is a ratio of a bank's capital to its risk...
(CAR) for a financial institution. In the Basel I
Basel I
Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee in Basel, Switzerland, published a set of minimal capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten countries...
accord published by the Basel Committee on Banking Supervision
Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1975. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance...
, 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
Standardized approach (credit risk)
The term standardized approach refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions....
or IRB
Internal Ratings-Based Approach (Credit Risk)
Under the Basel II guidelines, banks are allowed to use their own estimated risk parameters for the purpose of calculating regulatory capital. This is known as the Internal Ratings-Based Approach to capital requirements for credit risk...
approach under the Basel II
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...
framework.
Some assets, such as debentures, are assigned a higher risk than others, such as cash or government securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
/bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
. Since different types of assets have different risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
profiles, weighing assets based on the level of risk associated with them 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 Basel Committee on Banking Supervision
Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1975. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance...
which recommends certain standards and regulations for banks. This was called Basel I
Basel I
Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee in Basel, Switzerland, published a set of minimal capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten countries...
, and the Committee came out with a revised framework known as Basel II
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...
. More recently, the committee has published another revised framework known as Basel III
Basel III
BASEL III is a new global regulatory standard on bank capital adequacy and liquidity agreed upon by the members of the Basel Committee on Banking Supervision. The third of the Basel Accords was developed in a response to the deficiencies in financial regulation revealed by the global financial...
. The main recommendation of this document is that banks should hold enough capital to equal at least 8% of its risk-weighted assets. 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 ratioCapital requirement
Capital requirement refers to -The standardized requirements in place for banks and other depository institutions, which determines how much capital is required to be held for a certain level of assets through regulatory agencies such as the Bank for International Settlements, Federal Deposit...
, see