What is the purpose of risk-weighted assets (RWA) in Basel III?

• A. They adjust asset riskiness to determine capital requirements
• B. They measure liquidity risk
• C. They set leverage limits
• D. They determine tax liabilities

Answer: (A)

Risk-weighted assets translate how risky a bank’s assets are into the amount of capital it must hold. In Basel III, each asset is assigned a risk weight based on its credit, market, or operational risk, and the asset's balance is multiplied by that weight; summing across all assets gives total risk-weighted assets. This structure ensures that riskier assets require more capital to absorb potential losses, while safer assets require less. For example, cash or government securities typically carry low risk weights, whereas unsecured corporate loans carry higher ones. Banks then hold capital proportional to their RWA, tying capital requirements directly to the risk profile of the asset portfolio and strengthening resilience in downturns. RWA focus on capital adequacy, not liquidity risk (which is addressed by liquidity standards like the LCR and NSFR) or leverage limits, which Basel III covers through separate measures.