Dec 22, 20 counterparty credit risk and cva under basel iii 1. Counterparty credit risk, sa ccr, cva, otc derivatives, basel iii. Management, credit value adjustment and counterparty credit risk, and currency options trading and structuring. Credit risk rwas include risk weighted assets for general credit risk, securitization exposures, and equity exposures.
The basel committee on banking supervision has received a number of interpretation questions related to the december 2010 publication of the basel iii regulatory frameworks for capital and liquidity as well as the july. General credit risk involves consideration of wholesale and retail rwa as well as the counterparty credit risk of repostyle transactions, eligible margin loans, otc derivative contracts, cleared transactions, unsettled. Credit risk rwas include riskweighted assets for general credit risk, securitization exposures, and equity exposures. In this article, michael pykhtin proposes a general framework for calculating capital for ccr that consistently incorporates cva. Section v internal model method, section vi standardised method, and section vii current exposure method. Content counterparty credit risk ccr definition ccr management tools ccr indicators ccr and basel ii ccr and basel iii 3. The standardized approach proposal is based in significant part on the standardized approach for the weighting and calculation of riskbased capital requirements under the 20042006 basel 2 accord. List of figures 3 list of tables 4 abbreviations 5 executive summary 6 1. Abstract counterparty credit risk ccr management of today is a complex process involving many groups within financial institutions. Basel iii counterparty credit risk and exposures to central counterparties frequently asked questions update of faqs published in november 2012 also available in. Note 17 loans, allowance for loan losses and credit. The basel iii proposals for counterparty credit risk contain significant enhancements related to cva credit valuation adjustment and in particular the needs to account for variation in cva with a regulatory cva var computation.
For example, the capital charge for all corporate exposures was the same irrespective of the. Significant attention is devoted to basel iiis potential impact on banks and other financial institutions globally. The merger allows simplification of governance structures and increases operational. In case of default, the surviving party has to close out his position and usually seeks to replace. In order to recognize certain exposures as cleared transactions pursuant to paragraphs 1ii, or iv of the definition of cleared transaction in 3. The standardised approach for measuring counterparty credit risk exposures frequently asked questions 3 the trade in this example will be attributed to the intermediate maturity bucket between one and five. Basel iii comparison of standardized and advanced approaches. In an efficient market, higher levels of credit risk will be associated with higher borrowing. As a final step we merge collateral and netting agreement to compute the capital charge. Basel committee began issuing proposals to revise the credit risk. The basel committees final standard on the standardised approach for measuring counterparty credit risk exposures includes a comprehensive, nonmodelled approach for measuring counterparty credit risk associated with otc derivatives, exchangetraded derivatives, and long settlement transactions. The new standardised approach saccr replaces both the current exposure method cem and the. Counterparty credit risk ccr and collateral management. For purposes of calculating basel iii regulatory capital for counterparty credit risk, posted margin is reflected as a reduction to exposure at default.
The risk of counterparty default was already covered in basel i and basel ii. Counterparty credit risk is the risk that a party, usually to an otc derivative contract, may fail to fulfill its obligations, causing replacement losses to the other party. This work and the related pdf file are licensed under a creative commons. Part iii credit risk cra general information about credit risk b. It is due to replace both the current exposure method cem and the standardized method sm starting january 1, 2017. The basel 1988 capital accord introduced the concept of current exposure method cem being based on the replacement cost i. This course provides a comprehensive study of basel iiis credit risk requirements and an overview of market and operational risk requirements. Annex 4 treatment of counterparty credit risk and crossproduct netting a. Trading systems trades, market prices collateral system counterparty operations algo credit collateral data risk reports netting setup credit ratings trading systems trade algo credit incremental risk measures end of day.
The basel iii accord new standards for capital, liquidity. We present a brief comparison of the marked differences between the two documents. Counterparty credit risk, saccr, cva, otc derivatives, basel iii. Counterparty credit risk in basel iii executive summary. Abstract of basel iii counterparty credit risk and exposures to central counterparties frequently asked questions update of faqs published in november 2012, december 2012.
If firms merge, the assets issued by the new firm receive the liquidity value of. A credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments. Basel iii focused on enhancing the stability of the financial system by increasing both the. Measures to reduce credit risk include higher risk weighted assets rwa, the new credit value adjustment cva charge, identification of wrong way risk and upgrading stress tests. Measuring counterparty credit risk for trading products under. This led the basel committee on banking supervision bcbs to include a significant strengthening of its framework for counterparty credit risk ccr for securities financing transactions sfts and both overthecounter otc and centrally cleared derivatives in its basel iii. Cva is the market value of counterparty credit risk cva riskfree portfolio value true portfolio value accounting for counterpartys default cva is an integral component of the value of derivatives now an integral part of accounting rules, and basel iii prior to mid2007, cva was either ignored by dealers, or too small to be noticed.
The basel committee on banking supervision the basel committee recently published for comment a consultative document the proposal that describes a new noninternal model method nimm for measuring exposure at default ead used in measuring counterparty credit risk ccr for derivative transactions in capital adequacy calculations. Counterparty exposure management in the basel iii era. Revised metric to better address counterparty credit risk, credit valuation. Cva appears via a completely new cva capital charge and a downward adjustment of exposureatdefault. Basel previously covered the default capital charge for counterparty. Credit risk measures credit risk mitigation model implementation back testing regulatory requirements and basel iii counterparty credit risk and cva under basel iii patrick h. These disclosures should be read in conjunction with our quarterly report on form 10q. Weaknesses in risk management practices associated with derivatives were revealed by the great financial crisis. Credit risk data challenges underlying the new basel. The standardised approach for measuring counterparty. Dec 2012 basel iii counterparty credit risk and exposures to central.
Measuring counterparty credit risk for trading products. Basel iii counterparty credit metrics kamakura corporation. Calculating ead according to the new standardizes approach for counterparty credit risk saccr 9 capital requirements stepin risk cva risk operational risk market risk counterparty credit risk securitisation credit risk capital floors bcbs 306, bcbs 362 sa counterparty credit risk bcbs 279 interest rate risk in the banking. All basel iii amendments regarding counterparty credit risk. Changes to counterparty credit risk ccr basel iii introduced capital requirements to cover credit value adjustment.
Lack of sufficient risk differentiation for individual loans. Counterparty credit risk counterparty credit risk p. A global regulatory framework for more resilient banks and. The standardized approach for counterparty credit risk saccr is a new computational method for exposure at default ead under the basel capital adequacy framework. Rw based on credit risk of bank, but potentially floored at the rw of the banks sovereign external credit risk assessment approach. In addition there are significant changes related to credit risk. Replacement cost rc measures the current exposure to a counterparty for a given netting set, which may be reduced by collateral.
A global regulatory framework for more resilient banks and banking. The weights did not sufficiently differentiate credit risk by counterparty i. Basel iii is an extension of the existing basel ii framework, and introduces new capital and liquidity standards to strengthen the regulation, supervision, and risk management of the whole of the banking and finance sector. Capitalequirr ements stepin risk cva risk operational risk market risk counterparty credit risk securitisation credit risk capital floors bcbs 306, bcbs 362 sa counterparty credit risk bcbs 279 interest rate risk in the. Calculating ead according to the new standardizes approach for counterparty credit risk saccr saccr as part of the basel iv package banks play a major role in the global economy. The basel iii reforms introduced a new capital charge for the risk of loss due to the deterioration in the creditworthiness of the counterparty to s transaction or an sft. A second consultative paper was issued on 10th december 2015. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The counterparty credit risk is the risk of loss that is incurred by an institution in the event of default of its counterparty. For purposes of calculating riskweighted assets under subparts d and e of this part. Planning a basel iii credit risk initiative 5 the way we see it. Qualitative requirements for back and stress testing proposed remedies to better account for counterparty credit risk ccr i regulatory capital calculation. Basel iii standardized approach to counterparty credit risk.
Research thesis the impact of basel iii on the european. Ccra qualitative disclosure related to counterparty credit risk. Calculating cva capital charges basel iii quantifi. Best counterparty risk initiative american financial technology awards 2010. The basel ii framework was updated by the introduction of basel iii and the amended regime was implemented in the eu from 1 january 2014 by means of a directive and a regulation, collectively known as crd iv. The counterparty credit risk standards are set out in annex 4 of the basel ii framework. Counterparty credit risk is the risk taking into account. Global risk management 18 counterparty credit risk system at scotiabank in collaboration with ibm risk analyticsalgorithmics. Bis issued a first consultative paper on the revisions to the standardized approach to credit risk in december 2014. Basel committee on banking supervision basel iii counterparty credit risk and exposures to central counterparties frequently.
View essay bcbs237 from fin 385 at harding university. Counterparty credit risk substantial strengthening of the counterparty credit risk framework. I will describe scotiabanks award winning ccr initiative. Limits of basel ii2 reforms of basel iii1,3 objectives1,3 unclear and insufficient capital definition new capital definition see 3. Counterparty credit risk ccr and collateral management in.
Default counterparty credit risk was already accounted for but a bis study showed that two thirds of the losses due to counterparty risk during the financial crises resulted from the cva and not the default of the concerned counterparties. Introduction counterparty credit risk is the risk that the counterparty to a financial contract will default prior to the expiration of. Counterparty credit risk, basel iii and recent regulatory. Basel iii counterparty credit risk and exposures to. Measuring counterparty credit risk for trading products under basel ii michael pykhtin1 and steven zhu2 risk architecture bank of america september 18, 2006 1. The basel iii standard issued by bis has been up for discussion and debate. As a final step we merge collateral and netting agreement. Banks can take analytical techniques one stage further at predeal stage using realtime data. A revised version of basel iii was published on 1 june 2011 which made modifications to the proposals on counterparty credit risk. Calculating cva capital charges basel iii the global financial crisis brought counterparty credit risk and cva very much into the spotlight, this webinar explores the capital charges under the two regimes, the capital relief that can be achieved and the potential to reduce the capital charges via eligible hedges.
Pdf counterparty credit risk in otc derivatives under basel iii. In his last position, douglas was a principle in abn amros risk advisory services business and established the market risk and treasury advisory practice. Basel iii counterparty credit risk july 22, 20 the annex includes the steps for calculating rc and pfe under the nimm and provides a comparison to the calculations under the cem. Sound risk management is therefore fundamental to ensure their safety and survival. Counterparty credit risk in otc derivatives under basel iii. The main issue around whether credit insurance can be used as a risk mitigant in this way is the basel iii requirement for unconditionality. Basel committee revises basel iii on the capital treatment. This means that the instrument must be irrevocable and within the direct control of the protection purchaser i. Basel iii brings new standards around capital, liquidity and leverage. Counterparty credit risk is the risk taking into account the exposure of the financial institution to the counterparty if this latter defaults or has its credit quality devaluated.
Basel iii monitoring exercise european banking authority. Counterparty risk capital and cva basel iii has incorporated credit valuation adjustment cva in calculations of regulatory capital for counterparty credit risk ccr. The basel committee on banking supervision has received a number of interpretation questions related to the standardised approach for measuring counterparty credit risk saccr, as published in march 2014 and revised in april 2014. This document presents a set of frequently asked questions that relate to the saccr. Counterparty exposure management in the basel iii era a new regulation for counterparty exposure risk counterparty credit risk ccr is not a new area of regulation. Basel iii has carried out important reforms especially with regards to capital definition, the introduction of counterparty credit risk, leverage and liquidity ratios. Frequently asked questions on the basel iii standardised. Counterparty credit risk in financial institutions ivan sergienko. Counterparty credit risk and cva under basel iii 1. Basel iii establishes a capital adequacy framework, which provides for measuring required capital under two approaches applied in a.
For example, the capital charge for all corporate exposures was. We operate under a boardlevel approved risk framework which outlines our company. Faqs that have been added since the publication of the previous version of this document are shaded yellow. Therefore, basel iii amended the computation of an additional cva capital. Replacement cost rc measures the current exposure to a counterparty for a.
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