How is RWA calculated?

By Ritesh|Updated : September 4th, 2022

RWA is called a risk-weighted asset. It is found by multiplying the exposure value by the appropriate risk weight for the type of asset or loan. Banks find the total credit risk-weighted assets by repeating the above calculation for all their assets and loans. This asset calculation is done to determine the capital adequacy ratio called CAR.

Risk-weighted Assets

  • Risk-weighted assets are designed to respond to changes in the quality and composition of the bank's loan portfolio. When the credit risk increases, the risk-weighted assets are expected to increase to an extent.
  • The standardized and the IRB, an internal rating approach, calculate risk-weighted assets. Larger banks have the expertise and infrastructure necessary to use the IRB approach. In both approaches, the risk weight is multiplied by the exposure volume.
  • To protect customers or depositors from bank insolvency, APRA requires banks and other financial institutions to fund themselves with a minimum amount of capital. The APRA sets the minimum capital adequacy indicator to find the minimum amount of capital.
  • The Basel III Accord is a 2009 international regulatory agreement that introduced reforms designed to improve supervision, regulation, and risk management in the international banking sector. Base III requires banks to keep up proper leverage ratios and maintain certain levels of reserve capital.

Summary:

How is RWA calculated?

RWA is a Risk-weighted asset calculated by multiplying the exposure amount by the relevant risk weight for the type of asset or loan. It helps in determining the minimum amount to be held by banks and private institutions to reduce the risk of insolvency.

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