Definition of risk-weighted assets
Global banking supervisors based in Basel Switzerland use the concept of risk-weighted assets to determine a bank’s minimum capital needs. Risk-weighted assets are computed by adjusting each asset class for risk in order to determine a bank's real world exposure to potential losses. Regulators then use the risk weighted total to calculate how much loss-absorbing capital a bank needs to sustain it through difficult markets.
Under the Basel III rules, banks must have top quality capital equivalent to at least 7 per cent of their risk-weighted assets or they could face restrictions on their ability to pay bonuses and dividends.
The risk weighting varies accord to each asset's inherent potential for default and what the likely losses would be in case of default - so a loan secured by property is less risky and given a lower multiplier than one that is unsecured.
Under the Basel II banking accord, which still governs most risk-weighting decisions, government bonds with ratings above AA- have a weight of 0 per cent, corporate loans rated above AA- are weighted 20 per cent, etc. The rules also attempt to classify assets by their credit risk, operational risk and market risk.