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Risk-Weighted
Asset
Article by
Abhilash Ramachandran

Reviewed by
Dheeraj Vaidya, CFA, FRM

What is a Risk-
Weighted Asset?
Risk-Weighted Assets are 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.

Table of contents

What is a Risk-Weighted
Asset?
Risk-Weighted Asset
Formula

Risk-Weighted Asset
Calculation Examples

Advantages

Disadvantages

Conclusion

Recommended Articles

00:00/00:00

Risk-Weighted Asset
Formula
Capital Adequacy Ratio = Tier 1
Capital + Tier 2 Capital / Risk-
Weighted Assets
Therefore,

Risk-Weighted Assets = Tier 1

Capital + Tier 2 Capital / Capital
Adequacy Ratio

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Tier 1: Capital is a bank’s core

capital used at times of financial
emergency to absorb losses
without impacting daily
operations. It includes audited
revenue reserves, ordinary
share capital,
intangible assets, and future
tax benefits.

Tier 2: Capital is a bank’s

additional capital used to
absorb losses when winding up
an asset. It includes revaluation
reserves, perpetual cumulative
preference shares,
retained earnings,
subordinated debt, and
general
provisions for bad debt.

A bank or a financial institution with

a higher Capital Adequacy Ratio
indicates that it has sufficient
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 of failing
in case of an unexpected loss, which
means additional capital is required
to be safer. An investor will look to
invest in a business with 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.

Particulars Bank A Bank B

Tier 1 1000000 1500000

Tier 2 2500000 3100000

Capital Adequacy
8 7
Ratio

Calculation of the Risk-Weighted

Assets.

The risk-weighted average can be

calculated as below:

2) Bank A has the below portfolio,

Calculation of the risk-weighted for
the loans (assets)

Risk
Particulars $
Weight (%)

Government
20000 0
Securities

Shares 2000 125

Secured Loans 15000 0

Corporate Loans 50000 50

Other Loans 2000 100

Cash Balance 5000 0

Balance with
1000 20
Banks

Other Assets 6000 100

The risk-weighted asset can be

calculated as below:

Advantages
Ensures that banks and
financial institutions have a
minimum capital maintained
to be safe during uncertainty.

Encourages banks and

financial institutions to
review their current financial
condition and highlights any red
flags in case of minimum capital
requirement.

The Basel Committee on

Banking Supervision helps
banks achieve capital adequacy
goals.

It reduces the risk of

foreseeable risks

Disadvantages
It is backward-looking,
meaning; it assumes that
security that has been risky in
the past is the same as the
securities that will be risky in
the future.

Banks must hold more common

stocks since they need to find
less risky assets with returns.

The Basel II regulatory

framework assumes banks to
be in the best position to
measure their financial risks,
whereas, in reality, they might
not be.

Regulatory requirements have

made it mandatory for banks at
a global level to follow the Basel
framework, which requires
additional efforts on the bank’s
front. Although the process is
streamlined, it requires a lot of
manual effort.

Conclusion
Basel Committee on Banking
Supervision has formulated the
Basel Accord that provides
recommendations on risks
related to banking operations.
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 them as
much as possible

Recommended
Articles
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
–

Definition of Risk Transfer

Risk-Reward Ratio

Headline Inflation

Operational Risks Definition

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