Risk-Weighted Assets
Candlefocus EditorAn RWA is determined by a risk-weighted formula using a risk coefficient. The risk coefficients are derived from credit ratings assigned to certain types of bank assets. The higher the rating, the lower the risk associated with the asset and thus, the higher the risk weight. There are risk coefficients associated with assets classified as “low risk”, “medium risk”, and “high risk”. Assets with collateral, such as mortgage-backed securities, typically have a lower risk weight than those without collateral, such as unsecured loans.
Additionally, loans backed by collateral are treated more favorably under Basel III regulations because the collateral is considered in addition to the source of repayment when calculating the measurement of risk. In this way, the risk-weighted amount of capital a bank needs to hold for a particular asset is reduced. Ownership of a collateralized asset is considered to be a long-term investment and banks must maintain both the investments and the collateralized assets.
The risk-weighted formula takes into account credit ratings from qualified international rating agencies, including Moody’s, Standard & Poor’s, or Fitch. Individual countries may choose to deviate from the Basel III guidelines, allowing for different risk weightings; however, deviations can only be made in the case of large banking portfolios and are then generally used to increase the amount of protection for depositors.
Risk-Weighted Assets have become an important part of managing risk and protecting both depositors and shareholders. It allows banks to measure the amount of capital they must hold against an asset depending on its risk levels. By adjusting the weightings of an asset's risk, banks are better able to assess their own portfolios and manage the associated risks. This reduces the amount of financial stress on the institution, allowing it to remain stable and maximise profits in the long run.