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Calculation Methodology

This section explains how Risk-Weighted Assets (RWA) are calculated for credit risk exposures. Understanding these methodologies is essential for auditing results and validating regulatory compliance.

RWA Calculation Overview

Risk-Weighted Assets represent the risk-adjusted value of exposures, used to determine capital requirements:

Capital Requirement = RWA × Capital Ratio (typically 8%)

The calculator supports four main approaches:

Approach Description Applicable To
Standardised (SA) Regulatory risk weights All exposure classes
IRB Internal ratings-based Approved portfolios
Slotting Category-based weights Specialised lending
Equity Dedicated equity treatment Equity holdings

Calculation Pipeline

flowchart TD
    subgraph Input
        A[Raw Data]
    end

    subgraph Processing
        B[Hierarchy Resolution]
        C[Classification]
        D[CRM Application]
    end

    subgraph Calculation
        E{Approach}
        F[SA Calculator]
        G[IRB Calculator]
        H[Slotting Calculator]
    end

    subgraph Output
        I[Aggregation]
        J[Final RWA]
    end

    A --> B
    B --> C
    C --> D
    D --> E
    E -->|SA| F
    E -->|IRB| G
    E -->|Slotting| H
    F --> I
    G --> I
    H --> I
    I --> J

Key Formulas

Standardised Approach

RWA = EAD × Risk Weight × Supporting Factors

Where: - EAD = Exposure at Default (drawn + CCF × undrawn) - Risk Weight = Regulatory-prescribed weight based on rating/class - Supporting Factors = SME/infrastructure factors (CRR only)

IRB Approach

RWA = K × 12.5 × EAD × MA × Scaling Factor

Where: - K = Capital requirement from IRB formula - 12.5 = Reciprocal of 8% minimum capital ratio - EAD = Exposure at Default - MA = Maturity Adjustment - Scaling Factor = 1.06 (CRR) or 1.0 (Basel 3.1)

Slotting Approach

RWA = EAD × Slotting Risk Weight

Where: - Slotting Risk Weight = Based on category (Strong/Good/Satisfactory/Weak)

Calculation Components

Exposure at Default (EAD)

EAD is the expected exposure amount at the time of default:

Exposure Type EAD Calculation
On-Balance Sheet Gross carrying amount
Off-Balance Sheet Committed × CCF
Derivatives Mark-to-market + Add-on

Credit Conversion Factors (CCF)

CCFs convert off-balance sheet exposures to EAD:

Item Type CCF
Unconditionally Cancellable 0% (CRR) / 10% (Basel 3.1)
Short-term Trade Finance 20%
Undrawn Commitments 20-50%
Direct Credit Substitutes 100%

Risk Weights

Risk weights depend on: 1. Exposure class (Central Govt / Central Bank, Institution, Corporate, Retail, etc.) 2. Credit quality (CQS 1-6 or internal rating) 3. Collateral (secured vs unsecured) 4. Maturity (for certain exposures)

Credit Risk Mitigation (CRM)

CRM reduces exposure or substitutes risk weight:

flowchart LR
    A[Gross Exposure] --> B{CRM Type}
    B -->|Collateral| C[Apply Haircuts]
    B -->|Guarantee| D[Substitution]
    B -->|Provision| E[Reduce EAD/EL]
    C --> F[Net Exposure]
    D --> F
    E --> F
    F --> G[Calculate RWA]

See Credit Risk Mitigation for details.

Approach Selection

The calculation approach is determined by:

  1. Regulatory approval - IRB requires PRA approval
  2. Exposure class - Some classes have restricted approaches
  3. Data availability - IRB requires PD estimates
Exposure Class SA F-IRB A-IRB Slotting
Central Govt / Central Bank ✅ ✅ ✅
Institution ✅ ✅ ✅*
Corporate ✅ ✅ ✅*
Retail ✅ ✅
Specialised Lending ✅ ✅
Equity ✅ ✅

*Basel 3.1 restricts A-IRB for banks and large corporates

Framework Adjustments

CRR Adjustments

  1. 1.06 Scaling Factor: Applied to all IRB RWA
  2. SME Supporting Factor: 0.7619/0.85 tiered reduction
  3. Infrastructure Factor: 0.75 flat reduction

Basel 3.1 Adjustments

  1. Output Floor: max(IRB RWA, 72.5% × SA RWA)
  2. PD Floors: Differentiated by exposure class
  3. LGD Floors: For A-IRB by collateral type

Validation and Audit

Traceability

Every calculation can be traced: - Input values for each exposure - Intermediate calculations - Applied adjustments - Final RWA

Error Accumulation

The calculator accumulates errors without failing: 

result = pipeline.run(config)

for error in result.errors:
    print(f"{error.exposure_id}: {error.message}")

Reconciliation Points

Key reconciliation points: 1. EAD Total - Sum of all exposures at default 2. RWA by Approach - SA + IRB + Slotting 3. RWA by Exposure Class - Sum by classification 4. Floor Impact - IRB before and after floor (Basel 3.1)

Detailed Methodology

Explore each calculation approach in detail: