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Key Concepts

This page introduces the fundamental concepts used throughout the RWA calculator. Understanding these terms is essential for working with the system effectively.

Risk-Weighted Assets (RWA)

Risk-Weighted Assets (RWA) are a measure of a bank's assets, adjusted for risk. They are used to determine the minimum capital a bank must hold to remain solvent.

Capital Ratio = Regulatory Capital / RWA

The higher the risk of an asset, the higher its risk weight, and the more capital required.

Example

Asset Value Risk Weight RWA
UK Government Bond £100m 0% £0m
Corporate Loan (AAA) £100m 20% £20m
Corporate Loan (Unrated) £100m 100% £100m

Regulatory Frameworks

CRR (Capital Requirements Regulation)

The CRR implements Basel 3.0 standards in the UK. It is the current regulatory framework, effective until 31 December 2026.

Key features: - 1.06 scaling factor for IRB approaches - SME Supporting Factor (Article 501) - Infrastructure Supporting Factor - No output floor

Basel 3.1

Basel 3.1 (implemented via PRA PS1/26) introduces enhanced risk sensitivity and removes certain capital relief mechanisms. Effective from 1 January 2027.

Key features: - Removal of 1.06 scaling factor - Removal of supporting factors - Introduction of 72.5% output floor - Differentiated PD floors - A-IRB LGD floors

Calculation Approaches

The calculator supports four approaches, each with increasing risk sensitivity:

Approach Key Feature Who Estimates Risk?
Standardised (SA) Regulatory-prescribed risk weights based on ratings Regulator
Foundation IRB (F-IRB) Bank estimates PD; supervisory LGD/EAD Bank + Regulator
Advanced IRB (A-IRB) Bank estimates PD, LGD, and EAD Bank
Slotting Category-based (Strong/Good/Satisfactory/Weak/Default) for specialised lending Regulator

Details: See Standardised Approach, IRB Approach, and Specialised Lending for formulas, parameters, and worked examples.

Exposure Classes

Exposures are classified into regulatory categories based on the counterparty's entity type:

Class Description Typical Risk
Central Govt / Central Bank Governments and central banks Low-High
RGLA Regional governments, local authorities Low-Medium
PSE Public sector entities Low-Medium
MDB Multilateral development banks Low
Institution Banks, CCPs, financial institutions Medium
Corporate Non-retail companies Medium-High
Corporate SME Small/medium enterprises (turnover ≤ EUR 50m under CRR; ≤ GBP 44m under Basel 3.1) Medium
Retail Mortgage Residential mortgages Low-Medium
Retail QRRE Qualifying revolving retail Medium
Retail Other Other retail exposures Medium-High
Specialised Lending Project finance, object finance, IPRE Variable
Equity Equity holdings High
Defaulted Non-performing exposures Very High

Entity Type Classification

The counterparty's entity_type field is the single source of truth for exposure class determination. The calculator supports 17 entity types that map to both SA and IRB exposure classes.

For example: - pse_sovereign maps to PSE for SA (uses PSE risk weight table) but CENTRAL_GOVT_CENTRAL_BANK for IRB (uses central govt/central bank formula) - mdb maps to MDB for SA (typically 0% RW) but CENTRAL_GOVT_CENTRAL_BANK for IRB

See Classification for the complete entity type mapping and classification algorithm.

Key Metrics

Metric What It Measures Used In
EAD (Exposure at Default) Expected exposure if counterparty defaults. On-balance = drawn amount; off-balance = committed × CCF All approaches
PD (Probability of Default) Likelihood of default within one year (0.03%–100%) IRB only
LGD (Loss Given Default) % of exposure lost after recoveries. Supervisory in F-IRB, bank-estimated in A-IRB IRB only
CCF (Credit Conversion Factor) Converts off-balance sheet commitments to on-balance equivalents (0%–100%) All approaches

Details: See the Standardised Approach and IRB Approach for full parameter tables and floor values.

Credit Risk Mitigation (CRM)

CRM techniques reduce the capital required for an exposure:

  • Collateral — physical or financial assets securing an exposure, subject to supervisory haircuts
  • Guarantees — credit protection from a third party; the guaranteed portion is treated as an exposure to the guarantor (substitution approach)
  • Provisions — specific provisions reduce EAD for SA exposures or expected loss for IRB exposures

Details: See Credit Risk Mitigation for haircut tables, overcollateralisation ratios, maturity mismatch adjustments, and worked examples.

Data Hierarchy

Exposures follow a hierarchical structure:

graph TD
    A[Counterparty] --> B[Facility]
    B --> C[Loan/Draw]
    A --> D[Collateral]
    A --> E[Guarantee]
    A --> F[Rating]
    B --> G[Collateral]
    C --> H[Collateral]
  • Counterparty: The obligor (borrower)
  • Facility: A credit arrangement (e.g., credit line)
  • Loan: Individual draws or tranches

Ratings and collateral can be assigned at any level and inherit down the hierarchy.

Pipeline Stages

The calculation flows through six stages: Load → Hierarchy → Classify → CRM → Calculate → Aggregate.

Details: See Pipeline Architecture for the full stage-by-stage walkthrough with diagrams.

Next Steps