What are Risk Weighted Assets?

Calculation of the Ratio

The degree of risk expressed % weights assigned by the Reserve Bank of India. The following table shows the Risk weights for some important assets assigned by RBI in an increasing order.

Asset Weighted Risk
 Cash 0%
Balance with Reserve Bank of India 0%
Central/ state Government Guaranteed advances 0%
 SSI advances up to CGF guarantee 0%
Loans against FD (Fixed Deposits), LIC Policy 0%
 Government approved Securities 2.50%
Balance with Banks other than RBI which maintain the 9% CRAR  20%
Secured Loan to the Staff Members 20%
Housing Loans 50%
Housing Loans {amp}gt;Rs. 30 Lakhs 75%
Loans against Gold and Jewellery 50%
Retail Lending up to Rs. 5 crore 75%
Loans Guaranteed by DGCGC / ECGC 50%
Loans to Public Sector Undertakings 100%
Foreign Exchange and Gold in Open Position 100%
Claims on unrated corporates 100%
Commercial Real estate 100%
Consumer Credit 125%
Credit Cards 125%
Exposure to Capital Markets 125%
Venture Capital Investment as a part of Capital Market exposure 150%

In the above table we can have a broad idea that the assets which are in the form of Cash, Government Guaranteed securities, against the LIC policies etc. are safest assets with 0% Risk weighted assigned to them.

Under Basel-III, banks are to compute ratio as follows:

  • Common Equity Tier-I Capital Ratio = Common Equity Tier-I Capital / RWA for (Credit risk Market risk Operational risk)
  • Tier-I capital ratio = Tier-I Capital / RWA for (Credit risk Market risk Operational risk)
  • Total capital ratio (CRAR) = Eligible Total Capital / RWA for (Credit risk Market risk Operational risk)

Capital floor

In addition to proposing immediate improvements to the internal model-based approach, the Committee has made a proposal to enhance the comparability of the capital requirements of banks using internal models.

In early April, the Committee completed a consultation round in which the financial sector was asked to respond to proposals to subject risk-weighted assets based on internal models, to a minimum level ( floor).

Claims included in the regulatory retail portfolios

20.20

Claims that qualify under the criteria listed in CRE20.21 may be considered as retail claims for regulatory capital purposes and included in a regulatory retail portfolio. Exposures included in such a portfolio may be risk-weighted at 75%, except as provided in CRE20.26 for past due loans.

20.21

To be included in the regulatory retail portfolio, claims must meet the following four criteria:

(1)

Orientation criterion: The exposure is to an individual person or persons or to a small business;

(2)

Product criterion: The exposure takes the form of any of the following: revolving credits and lines of credit (including credit cards and overdrafts), personal term loans and leases (eg instalment loans, auto loans and leases, student and educational loans, personal finance) and small business facilities and commitments. Securities (such as bonds and equities), whether listed or not, are specifically excluded from this category. Mortgage loans are excluded to the extent that they qualify for treatment as claims secured by residential property (see CRE20.23).

(3)

Granularity criterion: The supervisor must be satisfied that the regulatory retail portfolio is sufficiently diversified to a degree that reduces the risks in the portfolio, warranting the 75% risk weight. One way of achieving this may be to set a numerical limit that no aggregate exposure to one counterpart11 can exceed 0.2% of the overall regulatory retail portfolio.

(4)

Low value of individual exposures: The maximum aggregated retail exposure to one counterpart cannot exceed an absolute threshold of €1 million.

20.22

National supervisory authorities should evaluate whether the risk weights in CRE20.20 are considered to be too low based on the default experience for these types of exposures in their jurisdictions. Supervisors, therefore, may require banks to increase these risk weights as appropriate.

Claims on multilateral development banks (MDBs)

20.4

Claims on sovereigns and their central banks will be risk weighted as follows:

Credit Assessment

AAA to AA-

A to A-

BBB to BBB-

BB to B-

Below B-

Unrated

Risk Weight

0%

20%

50%

100%

150%

100%

20.5

At national discretion, a lower risk weight may be applied to banks’ exposures to their sovereign (or central bank) of incorporation denominated in domestic currency and funded2 in that currency.3 Where this discretion is exercised, other national supervisory authorities may also permit their banks to apply the same risk weight to domestic currency exposures to this sovereign (or central bank) funded in that currency.

20.6

For the purpose of risk weighting claims on sovereigns, supervisors may recognise the country risk scores assigned by Export Credit Agencies (ECAs). To qualify, an ECA must publish its risk scores and subscribe to the Organisation for Economic Cooperation and Development’s (OECD) agreed methodology. Banks may choose to use the risk scores published by individual ECAs that are recognised by their supervisor, or the consensus risk scores of ECAs participating in the “Arrangement on Officially Supported Export Credits”.4 The OECD agreed methodology establishes eight risk score categories associated with minimum export insurance premiums. These ECA risk scores will correspond to risk weight categories as detailed below.

ECA risk scores

0-1

2

3

4 to 6

7

Risk weight

0%

20%

50%

100%

150%

20.7

Claims on the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Union, the European Stability Mechanism and the European Financial Stability Facility may receive a 0% risk weight.

20.8

Claims on domestic PSEs will be risk-weighted at national discretion, according to either option 1 or option 2 for claims on banks (see CRE20.14).5 When option 2 is selected, it is to be applied without the use of the preferential treatment for short-term claims.

20.9

Subject to national discretion, claims on certain domestic PSEs may also be treated as claims on the sovereigns in whose jurisdictions the PSEs are established.6 Where this discretion is exercised, other national supervisors may allow their banks to risk weight claims on such PSEs in the same manner.

20.10

The risk weights applied to claims on MDBs will generally be based on external credit assessments as set out under option 2 for claims on banks but without the possibility of using the preferential treatment for short-term claims. A 0% risk weight will be applied to claims on highly rated MDBs that fulfil to the Committee’s satisfaction the criteria provided below.7 The Committee will continue to evaluate eligibility on a case-by-case basis. The eligibility criteria for MDBs risk weighted at 0% are:

(1)

very high quality long-term issuer ratings, ie a majority of an MDB’s external assessments must be AAA;

(2)

shareholder structure is comprised of a significant proportion of sovereigns with long-term issuer credit assessments of AA- or better, or the majority of the MDB’s fund-raising are in the form of paid-in equity/capital and there is little or no leverage;

(3)

strong shareholder support demonstrated by the amount of paid-in capital contributed by the shareholders; the amount of further capital the MDBs have the right to call, if required, to repay their liabilities; and continued capital contributions and new pledges from sovereign shareholders;

(4)

adequate level of capital and liquidity (a case-by-case approach is necessary in order to assess whether each MDB’s capital and liquidity are adequate); and,

(5)

strict statutory lending requirements and conservative financial policies, which would include among other conditions a structured approval process, internal creditworthiness and risk concentration limits (per country, sector, and individual exposure and credit category), large exposures approval by the board or a committee of the board, fixed repayment schedules, effective monitoring of use of proceeds, status review process, and rigorous assessment of risk and provisioning to loan loss reserve.

20.11

There are two options for claims on banks. National supervisors will apply one option to all banks in their jurisdiction. No claim on an unrated bank, except for self-liquidating letters of credit, may receive a risk weight lower than that applied to claims on its sovereign of incorporation.

20.12

Under the first option, all banks incorporated in a given country will be assigned a risk weight one category less favourable than that assigned to claims on the sovereign of that country. However, for claims on banks in countries with sovereigns rated BB to B- and on banks in unrated countries the risk weight will be capped at 100%.

20.13

The second option bases the risk weighting on the external credit assessment of the bank itself with claims on unrated banks being risk-weighted at 50%. Under this option, a preferential risk weight that is one category more favourable may be applied to claims with an original maturity8 of three months or less, subject to a floor of 20%. This treatment will be available to both rated and unrated banks, but not to banks risk weighted at 150%.

20.14

The two options are summarised in the tables below.9

Option 1

Credit assessment of Sovereign

AAA to AA-

A to A-

BBB to BBB-

BB to B-

Below B-

Unrated

Risk weight under Option 1

20%

50%

100%

100%

150%

100%

Option 2

Credit assessment of Banks

AAA to AA-

A to A-

BBB to BBB-

BB to B-

Below B-

Unrated

Risk weight under Option 2

20%

50%

50%

100%

150%

50%

Risk weight for short-term claims under Option 2

20%

20%

20%

50%

150%

20%

20.15

When the national supervisor has chosen to apply the preferential treatment for claims on the sovereign as described in CRE20.5, it can also assign, under both options 1 and 2, a risk weight that is one category less favourable than that assigned to claims on the sovereign, subject to a floor of 20%, to claims on banks of an original maturity of 3 months or less denominated and funded in the domestic currency.

20.16

Claims on securities firms may be treated as claims on banks provided these firms are subject to supervisory and regulatory arrangements comparable to those under this Framework (including, in particular, risk-based capital requirements).10 Otherwise such claims would follow the rules for claims on corporates.

20.17

The table provided below illustrates the risk weighting of rated corporate claims, including claims on insurance companies. The standard risk weight for unrated claims on corporates will be 100%. No claim on an unrated corporate may be given a risk weight preferential to that assigned to its sovereign of incorporation.

Credit assessment

AAA to AA-

A to A-

BBB to BB-

Below BB-

Unrated

Risk weight

20%

50%

100%

150%

100%

20.18

Supervisory authorities should increase the standard risk weight for unrated claims where they judge that a higher risk weight is warranted by the overall default experience in their jurisdiction. As part of the supervisory review process, supervisors may also consider whether the credit quality of corporate claims held by individual banks should warrant a standard risk weight higher than 100%.

20.19

At national discretion, supervisory authorities may permit banks to risk weight all corporate claims at 100% without regard to external ratings. Where this discretion is exercised by the supervisor, it must ensure that banks apply a single consistent approach, ie either to use ratings wherever available or not at all. To prevent “cherry-picking” of external ratings, banks should obtain supervisory approval before utilising this option to risk weight all corporate claims at 100%.

Claims secured by commercial real estate

20.23

Lending fully secured by mortgages on residential property that is or will be occupied by the borrower, or that is rented, will be risk weighted at 35%. In applying the 35% weight, the supervisory authorities should satisfy themselves, according to their national arrangements for the provision of housing finance, that this concessionary weight is applied restrictively for residential purposes and in accordance with strict prudential criteria, such as the existence of substantial margin of additional security over the amount of the loan based on strict valuation rules. Supervisors should increase the standard risk weight where they judge the criteria are not met.

20.24

National supervisory authorities should evaluate whether the risk weights in CRE20.23 are considered to be too low based on the default experience for these types of exposures in their jurisdictions. Supervisors, therefore, may require banks to increase these risk weights as appropriate.

20.25

In view of the experience in numerous countries that commercial property lending has been a recurring cause of troubled assets in the banking industry over the past few decades, the Committee holds to the view that mortgages on commercial real estate do not, in principle, justify other than a 100% weighting of the loans secured.12

Determination of risk weightings for capital requirements

Banks are allowed to use internal models to determine their required capital, providing these models comply with the requirements set by the supervisory authorities.

A big advantage of the internally modelled approach is that capital requirements rise in tandem with the institution’s risk profile (risk sensitivity). This also stimulates banks to improve their quantitative risk management.

The current implementation of this approach also has its weaknesses, however. Banks are for instance given considerable room for bank-specific interpretation, and transparency about the relationship between risks and model outcomes is limited.

The alternative for determining capital requirements is the standardised approach: a simpler but less risk-sensitive method of determining risk weightings.

Exposures that give rise to counterparty credit risk

20.46

For exposures that give rise to counterparty credit risk according to CRE51.4 (ie OTC derivatives, exchange-traded derivatives, long settlement transactions and securities financing transactions), the exposure amount to be used in the determination of RWA is to be calculated under the rules set out in CRE50 to CRE54.

How does this work?

Let’s take this example, For a AAA client, the risk weight is 20%, which means banks have to set aside its own capital of ` 1.80 for every Rs 100 loan (this means 20% of 9% of ` 100). Similarly, in case of 100% risk weight (such as capital markets exposures) , banks have to keep aside its own capital of Rs 9 on the loan.

Impact of the proposals

The Basel Committee is currently reviewing the standardised approach. The purpose of the review is to enhance the risk-sensitivity of the standardised approach and to reduce the use of external ratings.

The Basel Committee is also working on proposals intended to respond to the lack of confidence in the use of internal models by banks. Important elements here are the ongoing harmonisation of internal models and the increased transparency on the model outcomes.

The impact of the various Basel proposals is as yet unclear as the proposals are still to be finalised. What is clear, however, is that the proposed risk weightings under the reviewed standardised approach combined with the proposed floor could significantly increase the capital requirements for Dutch banks.

For Dutch banks, the impact may be considerable as the internally modelled approach generally leads to lower risk weightings than the standardised approach. The difference is particularly significant for Dutch mortgage portfolios as the risk weightings based on internal models are relatively low, due to the low credit losses on Dutch mortgage portfolios, while risk weighting based on the standardised approach will be relatively high as this approach to a large extent depends on the loan-to-value ratio of mortgages.

The increasing importance of loan-to-value ratios could also push up capital requirements for Dutch banks using the standardised approach for risk weightings of mortgage portfolios.

It is important to formulate capital requirements that are consistent with the level of risk in the portfolios to which they apply. In the Basel Committee on Banking Supervision, De Nederlandsche Bank is pressing for an approach that does justice to the risk profiles of Dutch mortgage portfolios.

Introduction

20.1

Banks can choose between two broad methodologies for calculating their risk-based capital requirements for credit risk. The first is the standardised approach, which is set out in chapters CRE20 to CRE22:

(1)

The standardised approach assigns standardised risk weights to exposures as described in this chapter, CRE20. Risk weighted assets are calculated as the product of the standardised risk weights and the exposure amount. Exposures should be risk-weighted net of specific provisions (including partial write-offs).

(2)

To determine the risk weights in the standardised approach for certain exposure classes, banks may use assessments by external credit assessment institutions that are recognised as eligible for capital purposes by national supervisors. The requirements covering the use of external ratings are set out in chapter CRE21.1

(3)

The credit risk mitigation techniques that are permitted to be recognised under the standardised approach are set out in chapter CRE22.

20.2

The second risk-weighted capital treatment for measuring credit risk, the internal ratings-based (IRB) approach, allows banks to use their internal rating systems for credit risk, subject to the explicit approval of the bank’s supervisor. The IRB approach is set out in chapters CRE30 to CRE36.

20.3

The treatment of the following exposures is addressed in separate chapters of the credit risk standard:

(1)

Equity investments in funds are addressed in CRE60.

(2)

Securitisation exposures are addressed in CRE40 to CRE43.

(3)

Exposures to central counterparties are addressed in CRE54.

(4)

Exposures arising from failed trades and non-delivery-versus-payment transactions, are addressed in CRE70.

Next stages in the process

The Basel Committee is not expected to take any decisions on the review of the standardised approach and the proposed floor before the end of 2015. The Basel agreements will serve as a basis for the European Commission to prepare the relevant legislation.

Processes of this kind usually take several years. Until there is more clarity on the final outcome of the capital requirements review, banks would do well to factor in an increase in capital requirements in their strategies and business operations.

Off-balance sheet items

20.36

Off-balance-sheet items under the standardised approach will be converted into credit exposure equivalents through the use of credit conversion factors (CCF). Counterparty risk weightings for over-the-counter (OTC) derivative transactions will not be subject to any specific ceiling.

20.37

Commitments with an original maturity up to one year and commitments with an original maturity over one year will receive a CCF of 20% and 50%, respectively. However, any commitments that are unconditionally cancellable at any time by the bank without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower’s creditworthiness, will receive a 0% CCF.15

20.38

Direct credit substitutes, eg general guarantees of indebtedness (including standby letters of credit serving as financial guarantees for loans and securities) and acceptances (including endorsements with the character of acceptances) will receive a CCF of 100%.

20.39

Sale and repurchase agreements and asset sales with recourse,16 where the credit risk remains with the bank will receive a CCF of 100%.

20.40

A CCF of 100% will be applied to the lending of banks’ securities or the posting of securities as collateral by banks, including instances where these arise out of repo-style transactions (ie repurchase/reverse repurchase and securities lending/securities borrowing transactions). See CRE22.37 to CRE22.80 for the calculation of risk-weighted assets where the credit converted exposure is secured by eligible collateral. This paragraph does not apply to posted collateral that is treated under either the standardised approach to counterparty credit risk (CRE52) or the internal models method for counterparty credit risk (CRE53) calculation methods in the counterparty credit risk framework.

20.41

Forward asset purchases, forward forward deposits and partly-paid shares and securities17, which represent commitments with certain drawdown will receive a CCF of 100%.

20.42

Certain transaction-related contingent items (eg performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions) will receive a CCF of 50%.

20.43

Note issuance facilities and revolving underwriting facilities will receive a CCF of 50%.

20.44

For short-term self-liquidating trade letters of credit arising from the movement of goods (eg documentary credits collateralised by the underlying shipment), a 20% CCF will be applied to both issuing and confirming banks.

20.45

Where there is an undertaking to provide a commitment on an off-balance sheet item, banks are to apply the lower of the two applicable CCFs.

Other assets

20.32

The risk weight for investments in significant minority- or majority-owned and –controlled commercial entities is determined according to two materiality thresholds:

(1)

for individual investments, 15% of the bank’s capital; and

(2)

for the aggregate of such investments, 60% of the bank’s capital.

20.33

Investments in significant minority- or majority-owned and –controlled commercial entities below the materiality thresholds in CRE20.32 must be risk-weighted at 100%. Investments in excess of the materiality thresholds must be risk-weighted at 1250%.

20.34

A deduction treatment is specified in CAP30.32 for the following exposures: significant investments in the common shares of unconsolidated financial institutions, mortgage servicing rights, and deferred tax assets that arise from temporary differences. The exposures are deducted in the calculation of Common Equity Tier 1 (CET1) if they exceed the thresholds set out in CAP30.32 and CAP30.33. As specified in CAP30.34, the amount of the items that are not deducted in the calculation of CET1 will be risk weighted at 250%.

20.35

The standard risk weight for all other assets will be 100%.14 Investments in equity or regulatory capital instruments issued by banks or securities firms will be risk weighted at 100%, unless deducted from the capital base according CAP30.

Past due loans

20.26

The unsecured portion of any loan (other than a qualifying residential mortgage loan) that is past due for more than 90 days, net of specific provisions (including partial write-offs), will be risk-weighted as follows: 13

(1)

150% risk weight when specific provisions are less than 20% of the outstanding amount of the loan;

(2)

100% risk weight when specific provisions are no less than 20% of the outstanding amount of the loan;

(3)

100% risk weight when specific provisions are no less than 50% of the outstanding amount of the loan, but with supervisory discretion to reduce the risk weight to 50%.

20.27

For the purpose of defining the secured portion of the past due loan, eligible collateral and guarantees will be the same as for credit risk mitigation purposes (see chapter CRE22). Past due retail loans are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion specified in CRE20.21, for risk-weighting purposes.

20.28

In addition to the circumstances described in CRE20.26, where a past due loan is fully secured by those forms of collateral that are not recognised in CRE22.37 and CRE22.39, a 100% risk weight may apply when provisions reach 15% of the outstanding amount of the loan. These forms of collateral are not recognised elsewhere in the standardised approach. Supervisors should set strict operational criteria to ensure the quality of collateral.

20.29

In the case of qualifying residential mortgage loans, when such loans are past due for more than 90 days they will be risk weighted at 100%, net of specific provisions. If such loans are past due but specific provisions are no less than 20% of their outstanding amount, the risk weight applicable to the remainder of the loan can be reduced to 50% at national discretion.

Higher-risk categories

20.30

The following claims will be risk weighted at 150% or higher:

(1)

Claims on sovereigns, PSEs, banks, and securities firms rated below B-.

(2)

Claims on corporates rated below BB-.

(3)

Past due loans as set out in CRE20.26.

20.31

National supervisors may decide to apply a 150% or higher risk weight reflecting the higher risks associated with some other assets.

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