What kind of risk weight is applied to loan portfolios with lower ratings? Select one: A....

What kind of risk weight is applied to loan portfolios with lower ratings? Select one: A. -50. B. 0. C. 100. D. -10

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Expert Solution

Risk weighted assets are used to determine the minimum amount of capital required by financial institutions to reduce risk of insolvency. Every loan is given a risk weight. The weight is directly related to the probability of default of such loan.

Basel III is a set of international banking regulations designed to improve the health of banks. It contains guidelines for risk assessment. Credit ratings are also used to ascertain risk coefficients. The higher the credit rating, the secured the loan is and the lower will be the risk weight. But when credit rating is low, it means chances of default is high. Thus, we would need a higher risk weight.

Option A. False. Risk weight cannot be negative.

B. False. Risk weight will be zero for highly risk free assets. For example, if reserve bank takes loan from commercial banks, the risk of default is practically zero. Only for such extremely safe loans are risk weight allowed to be zero.

C. True. As rating is low, risk is bound to be high. Thus risk weights will be high. This option is correct. Note that if options were not given it would have been difficult to answer. Only with comparison to other options can you say with certainty in this question that this answer is correct.

D. False as risk weight cannot be negative.

jeff jeffy answered 1 year ago

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