Risk-Weighted Assets: Meaning, Formula, Examples, How to Calculate It?

There are risks of loan default when banks or financial institutions lend loans or offer investments to their customers or investors. To mitigate such insolvency risks, the banks tend to keep a reserve of minimum capital. Calculating their risk-weighted assets helps such financial institutions to understand the total risk weight of every asset.

This article provides details on risk-weighted assets, its importance, formula, calculation, ratio, etc. 

What is Risk-Weighted Assets (RWA)?

When a lender sanctions loans, they earn some interest on them, and this acts as one of the main investments of a bank or financial institution. However, certain risks are associated if the borrower fails to pay the outstanding amount. Therefore, the banks have to keep an amount aside to face loan defaults and tackle such situations.

The Risk Weighted Asset model was introduced by the Basel Committee on Banking Supervision (BCBS) in 1988. According to this, lenders or banks need to maintain a minimum of 8% capital adequacy ratio. However, in India, RBI instructed the scheduled commercial banks to maintain at least a 9% capital adequacy ratio as RWA and for public sector banks, this is 12%.

Capital to Risk-Weighted Assets Ratio

Capital to risk-weighted assets ratio is a ratio that indicates a bank’s capital to its current liabilities and risk-weighted assets. The regulators and the central banks decide this ratio to avoid any type of financial crisis in banks.

Risk-Weighted Assets Formula

There are two different formulas to calculate the risk-weighted assets:

• Formula 1: 

If you already have your capital adequacy ratio handy, you can use this formula:

Risk-weighted assets = (Tier 1 + Tier 2 Capital) ÷ capital adequacy ratio

• Formula 2: 

In case the capital adequacy ratio is not available, you can use this formula:

Step 1: Calculate the risk of every asset belonging to the financial institution/bank

Step 2: Add the values

The final figure is the total risk-weighted asset or total RWA of the lender.

Risk-Weighted Assets Ratio

The risk-weighted assets ratio is also known as the capital adequacy ratio. This ratio is very important for investors and analysts to realise the financial stability of a lender. This ratio is maintained to maintain a healthy financial ratio and protect the depositors of a bank.

Risk-Weighted Assets Examples

Some of the most popular examples of risk-weighted assets are debentures, treasury bills and government bonds. 

How to Calculate Risk-Weighted Assets?

You can calculate risk-weighted assets by following the above-mentioned formulas. Here are some examples of the formulas to help you understand them in a better way.

• Formula 1:

For example, the capital adequacy ratio of Bank ABC is 7

Tier 1 capital=5,00,000

Tier 2 capital=20,00,000

Total=25,00,000

RWA (using formula (Tier 1 + Tier 2 Capital) ÷ capital adequacy ratio)=3,57,143

• Formula 2:

Follow the table to get an example of formula 2:

Risk-Weighted Assets Table

This is the risk-weighted assets table as per the notification from the Reserve Bank of India (RBI):

*The data in this table may change over time.

Overall, risk-weighted assets are essential to analyse for banks and financial institutions to keep themselves prepared for the insolvency of any investment. By following the ratio formula, you can easily understand the risk-weighted assets of your bank and make informed decisions accordingly.