Question

1. In an essay of 100 words or less, define the term “risk-weighted assets” in the context of the Basel accords. How are risk-weighted assets different from total assets? Can a bank’s total assets increase while its risk-weighted assets stay the same?
2. In an essay of 120 words or less, explain the difference between expected losses (EL) and unexpected losses (UL) within a credit risk management context.

Answer 1

Risk-weighted assets are used to determine the minimum amount of capital that must be held by banks and other financial institutions in order to reduce the risk of insolvency. The capital requirement is based on a risk assessment for each type of bank asset. Basel III, a set of international banking regulations, sets the guidelines around risk-weighted assets.Regulators now insist that each bank must group its assets together by risk category so that the amount of required capital is matched with the risk level of each asset type. Basel III uses credit ratings of certain assets to establish their risk coefficients. The goal is to prevent banks from losing large amounts of capital when a particular asset class declines sharply in value.

The Risk Weighted Assets (RWA) refer to the fund based assets such as Cash, Loans, Investments and other assets.
Degree of risk expressed % weights assigned by the Reserve Bank of India yes a bank’s total assets increase while its risk-weighted assets stay the same

B.

In general, expected loss as the name suggests is the expected loss from a loan exposure. On the other hand unexpected loss is the loss that exceeds the expectations.

Expected Loss
In statistical terms, the expected loss is the average credit loss that we would expect from an exposure or a portfolio over a given period of time.

Unexpected Loss
The unexpected loss is the average total loss over and above the mean loss. It is calculated as a standard deviation from the mean at a certain confidence level at a certain confidence level. It is also referred to as Credit VaR.