Risk-weighted assets
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Regulatory Capital Anatomy™
The JC’s untutored thoughts on how bank capital works.
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Risk-weighted assets are used to determine the minimum amount of capital that banks and other financial institutions must hold to guard against their risk of insolvency. It is based on a risk assessment for each type of asset. For example, a loan that is secured by a letter of credit is considered to be riskier and requires more capital than a loan that is secured with a mortgage.
The global financial crisis was something of a come-to-Jehosophat moment for the Basel boxwallahs, as it turned out not to be a very good measure of risk, being somewhat counter-cyclical. So they in Basel III they introduced the leverage ratio to capture risks that they decided the RWA measure wasn’t capturing.