Risk-Weighted Assets

A bank holding $1 billion of US Treasury bonds and a bank holding $1 billion of loans to small unrated businesses have the same size balance sheet, but nobody would say they carry the same risk. If regulators required both banks to hold the same amount of capital against these assets, they'd be forcing the safer bank to over-capitalize and letting the riskier one under-capitalize. Risk-weighted assets (RWA) exist to fix that mismatch: they scale each asset by a risk weight before capital requirements are applied.

How the weighting works

Each asset class gets a risk weight, expressed as a percentage. A holding of government bonds from a highly rated sovereign might carry a 0% weight — contributing nothing to RWA even though it sits on the balance sheet. A residential mortgage might carry 35–50%. An unsecured loan to a low-rated corporate borrower might carry 100% or more. Multiplying each asset's dollar exposure by its weight and summing across the whole balance sheet gives total RWA — the number regulatory capital ratios are actually measured against, not the raw balance sheet total.

Worked example

A bank holds $500 million of AAA sovereign bonds (0% weight), $800 million of residential mortgages (45% weight), and $300 million of unrated corporate loans (100% weight). RWA from these three positions: $500\text{m} \times 0 = 0$, $800\text{m} \times 0.45 = 360\text{m}$, and $300\text{m} \times 1.00 = 300\text{m}$, for total RWA of $660 million — well below the $1.6 billion of raw exposure. If the bank must hold capital equal to 10% of RWA, that's $66 million of capital, not $160 million.

What this means in practice

RWA is the denominator in almost every regulatory capital ratio a bank reports, including its core CET1 ratio. That makes RWA itself a lever banks actively manage: shifting the mix of the balance sheet toward lower-weighted assets, or negotiating for internal-model-based weights instead of the standardised ones, directly reduces required capital for the same nominal exposure — which is exactly why regulators scrutinize both the weighting rules and how faithfully banks apply them.