Risk-Weighted Asset

What is Risk-Weighted Asset?

Risk-Weighted Assets is the minimum amount of capital that a bank or other financial institution must hold to cover an unexpected loss arising out of the inherent risk of its assets and doesn’t get bankrupt.

Risk-Weighted Asset Formula

Capital Adequacy Ratio = Tier 1 Capital + Tier 2 Capital / Risk-Weighted Assets

Therefore,

Risk-Weighted-Assets

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For eg:
Source: Risk-Weighted Asset (wallstreetmojo.com)

A bank or a financial institution with a higher Capital Adequacy RatioCapital Adequacy RatioThe capital adequacy ratio measures the bank's financial ability to pay off its obligations. The capital-to-risk weighted assets ratio (CRAR) is evaluated as the percentage of the bank's capital to its risk-weighted assets. Bank's capital is the aggregate of tier 1 and tier 2 capital.read more indicates that it has a sufficient amount of capital to meet unexpected losses. Inversely, when the capital adequacy ratio is low, it indicates that the bank or the financial institutions stand a chance to fail in case of an unexpected loss, which means additional capital is required to be on the safer side. An investor will look to invest in a business that has a higher Capital Adequacy Ratio.

Risk-Weighted Asset Calculation Examples

1) The below table has information regarding Tier 1 and 2 capital for Bank A and Bank B.

You can download this Risk-Weighted Asset Excel Template here – Risk-Weighted Asset Excel Template

It also gives the Capital Adequacy Ratio for these two banks.

ParticularsBank ABank B
Tier 110000001500000
Tier 225000003100000
Capital Adequacy Ratio87

Calculation of the Risk-Weighted Assets.

The risk-weighted average can be calculated as below:

Risk-Weighted Asset Example 1-1

2) Bank A has the below portfolio, Calculation of the risk-weighted for the loans (assets)

Particulars$Risk Weight (%)
Government Securities200000
Shares2000125
Secured Loans150000
Corporate Loans5000050
Other Loans2000100
Cash Balance50000
Balance with Banks100020
Other Assets6000100

The risk-weighted asset can be calculated as below:

Example 1-3

Advantages

Disadvantages

Conclusion

  • Basel Committee on Banking Supervision has formulated the Basel Accord that provides recommendations on risks related to banking operations. The aim of these accords, namely, Basel I, Basel II, and Basel III, is to ensure that banks and financial institutions have the required amount of capital to absorb the unexpected losses.
  • Risk-Weighted Asset enables a comparison between two different banks operating in two different regions or countries.
  • A high risk-weighted asset means the assets held are risky and would require a higher capital to be maintained.
  • A low risk-weighted asset means the assets held are less risky and would require lower capital to be maintained.
  • It looks at foreseeing potential risks and mitigating the risk as much as possible.

This has been a guide to What is Risk-Weighted Asset and its Definition. Here we discuss the formula to calculate risk-weighted assets along with examples, advantages, and disadvantages. You can learn more about excel modeling from the following articles –