Risk-weighted assets

Also called: RWA · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

Risk-weighted assets (RWA) are a bank's assets, each multiplied by a risk weight (a percentage set by how risky the asset is), then added together. Since Basel II, RWA also include amounts for market risk and operational risk, not only credit risk.

• Formula: RWA = Σ (each asset × its risk weight)

• Why it matters: RWA is the denominator (the bottom number) of the capital adequacy ratio: CRAR = (Tier 1 capital + Tier 2 capital) ÷ Risk-weighted assets × 100

• A bank holding riskier assets has higher RWA, so it must hold more capital. Safer assets need less capital.

Explanation

How risk weights work

• Each asset gets a risk weight based on how likely it is to cause a loss.
• Government securities (G-secs): 0%. The government is not expected to default (fail to repay) in its own currency.
• Home loans: the weight depends on the LTV band. LTV (loan-to-value) is the loan amount as a share of the house's value. A smaller loan against the house gets a lower weight.
• Unsecured consumer credit (personal loans, credit cards, with nothing pledged as security): higher weights.

• Most corporate loans: 100% under Basel I.

• Basel I (1988) used a few rough buckets from 0% to 100%. It covered credit risk only (the risk that a borrower does not repay).

• Basel II (2004) added two more risks to the RWA calculation:
• Market risk: losses when bond prices, share prices, exchange rates or interest rates move.
• Operational risk: losses from fraud, system failure or human error.

Worked example

Asset	Amount (Rs)	Risk weight	RWA (Rs)
G-secs	300	0%	0
Home loans	400	35%	140
Corporate loans	300	100%	300
Total	1,000		440

• Capital = Rs 50, so CRAR = 50 ÷ 440 ≈ 11.4%.
• This is above India's 9% minimum.

• It is just below 11.5%, the minimum once the capital conservation buffer is added. So the bank faces limits on paying dividends.

• Trap: capital ÷ total assets = 50 ÷ 1,000 = 5%. That is a different ratio, close to the leverage ratio. The CRAR divides by risk-weighted assets.

What makes RWA rise or fall

• Moving money into riskier assets raises RWA:
• Say the bank moves Rs 100 from G-secs (0%) into corporate loans (100%).
• RWA goes up from Rs 440 to Rs 540.

• With the same Rs 50 of capital, CRAR falls to about 9.3%.

• Moving money into safer assets lowers RWA. Buying G-secs adds nothing to RWA.

• The method used to set weights matters:
• Standardised approach: the regulator sets the weights, based on external credit ratings.
• Internal ratings-based approach: the bank uses its own models.
• Weakness shown in 2008: banks' own models showed low risk weights, so RWA looked small. Banks then held too little capital.

Fixes for "gaming" RWA

• Gaming risk weights means showing assets as safer than they really are, so RWA and the capital needed both look smaller.
• Leverage ratio (Basel III, 2010): Tier 1 capital ÷ total exposure, with no risk weights. It is a simple backstop that still works if RWA are gamed.
• Output floor (Basel III final reforms, "Basel IV", 2017): RWA from a bank's own models cannot fall below a set share of the RWA worked out under the standardised approach.

In India

• The RBI sets the rules on RWA and capital. The Basel norms are made by the BCBS (Basel Committee on Banking Supervision, based at the BIS in Basel). They are not legally binding until a national regulator adopts them.
• Timeline:
• India adopted Basel I in 1992, then raised the minimum capital to 9% of RWA from 2000.
• Basel II came to India in 2008-09.

• Basel III capital rules took effect from 1 April 2013, and banks must meet them on an ongoing basis. [1] Full phase-in was in October 2021.

• Minimums set as a share of RWA (RBI):

• CET1 (Common Equity Tier 1, the best-quality capital, such as shares and retained profits): 5.5%
• Tier 1: at least 7% of RWA. [1]
• Total CRAR: 9%, not counting the buffers. [1]
• Capital conservation buffer (CCB): another 2.5% of RWA, held in CET1. This makes CET1 + CCB = 8%, and total + CCB = 11.5%.

• Countercyclical capital buffer (CCyB): 0-2.5% of RWA, built up in credit booms and released in downturns. In April 2022 the RBI said it was not necessary to activate it. [2]

• Tier 2 limit linked to RWA: general provisions count in Tier 2 only up to 1.25% of credit RWA.

• Latest position: the CRAR of scheduled commercial banks rose from 12.94% (March 2015) to 17.36% (March 2025). CET1 rose from 9.98% to 14.81%. [4]
• Stress tests (the RBI's simulations of a bad economy) show banks' total capital stays above the regulatory minimum even in adverse scenarios (Financial Stability Report, June 2026). [3]

Don't confuse with

• Total assets / leverage ratio: the leverage ratio divides Tier 1 capital by total exposure with no risk weights. RWA always use risk weights.
• CRAR: CRAR is the ratio (capital ÷ RWA × 100). RWA is only the denominator. A fall in RWA raises CRAR.
• Risk weight: the risk weight is the percentage given to one asset (for example, 0% for G-secs). RWA is the total in rupees after applying all the weights.
• Tier 1 / Tier 2 capital: these are the numerator (the bank's own funds that absorb losses). RWA measure how much risk that capital must cover.

Prelims Hooks

• CRAR = (Tier 1 + Tier 2) ÷ RWA × 100. The leverage ratio = Tier 1 ÷ total exposure, with no risk weights.
• Basel I (1988): capital of 8% of RWA, credit risk only, weights from 0% to 100%. Market and operational risk entered RWA only with Basel II.
• G-secs carry a 0% risk weight. So buying G-secs adds nothing to RWA.
• India's minimums as a share of RWA: CET1 5.5%, Tier 1 7%, CRAR 9% [1]. With the CCB: 8% / 11.5%.
• Trap: general provisions count in Tier 2 only up to 1.25% of credit RWA, not in Tier 1.
• Output floor (2017): puts a lower limit on RWA from banks' own models, set against the standardised approach.

Mains Points

• Risk sensitivity vs gaming: RWA link capital to real risk, which is fairer than a flat rule.
• But banks' own models gave low weights before 2008, so they held too little capital.

• This led to the leverage ratio and the output floor. A good answer argues no single ratio is enough; capital, liquidity, supervision (Pillar 2) and disclosure (Pillar 3) must work together.

• Safety vs credit growth: loans with high risk weights, such as MSME and unsecured loans, raise RWA and so need more capital.

• Banks short of capital cut such loans first.

• This happened in 2017-18, when several PSBs were under Prompt Corrective Action (PCA), the RBI's framework of restrictions on weak banks. A good answer weighs the fiscal cost of recapitalising PSBs against the growth cost of tight credit.

• Macroprudential use of RWA: the CCB and CCyB are set as a share of RWA to guard against periods of excess credit growth. [1]

• The RBI has not activated the CCyB. [2]
• A good answer can ask whether the credit-to-GDP gap is the right trigger for a fast-growing, under-banked economy, where credit rises naturally as more people and firms get access to banks.

Related concepts

• Leverage
• Basel norms
• Basel I
• Basel II
• Three pillars of Basel
• Capital adequacy ratio
• Tier 1 capital
• Common Equity Tier 1
• Additional Tier 1 capital
• Tier 2 capital

Read more

• Capital adequacy: Basel I to Basel III