Basel IV – Credit Risk – Credit Value Adjustment (CVA) – Allowable Methods to calculate CVA

NEW CVA APPROACHES

Introduction

The main reason that drives the changes in approaches is to increase the transparency and comparability of CVA for regulators.

It’s become less flexible but it doesn’t mean less work for banks!

Revision of the Standardised Approach (SA-CVA)

The Standardized Approach (SA-CVA) closely follows the sensitivity-based standard approach of the FRTB (Fundamental Review of the Trading Book) framework for market risk. Similarly, the SA- CVA requires internal modeling of sensitivities for given market risk factors and especially the counterparty credit spread. In that sense, the SA-CVA is de facto an internal model. The application of the SA-CVA approach is subject to the approval of the competent authority and has been linked to a set of qualitative requirements.

Moreover, Standardised Approach-CVA approach is similar to Basic Full Approach (below) but allows to measure CVA more precisely due to bucketing of exposures and allocating risk drivers more accurately (= more cases to consider).

Risk weights are multiplied by sensitivities what is not possible for basic approaches

Introduction of a basic approach (BA-CVA)

There are 2 types of BA-CVA.

• Basic reduced approach - Excludes hedges and requires correlation, risk weight, maturity, EAD and supervisory discount factor
• Basic full approach - Same as above but it also allows for reduction in CVA due to hedging (limited to 25% of the capital charge)

The BA-CVA distinguishes between a reduced version and a full version of the approach. The reduced version of the basic approach does not take into account hedge transactions. The reduced BA-CVA thus also follows the principle of proportionality and was designed with the intention of providing smaller banks, with no hedging portfolios, with an easier-to-implement approach. The banks themselves can choose which version of the BA-CVA to use.

The BA- CVA approach is based on a system for applying regulatory risk weights, which, depending on sectors, lead to input parameters in given formulas. The risk weights differentiate between investment grade (IG), high yield (HY) and non-rated (NR) as well as different sectors (including “Other sector“).

Abolition of the internal model approach (IMA-CVA)

The IMA-CVA approach is eliminated under Basel IV. 

No approach

CVA is equal to 100% EAD value calculated in the “credit risk” of CCR (Counterparty Credit Risk).

By: Mark Dougherty, CPA, CMA (Chartered Professional Accountant, Certified Management Accountant)

London, UK – 27 November, 2019

Basel IV, Credit Risk - Article # 9

* - Basel IV is now part of the regular vernacular. Basel IV is not a single regulatory framework, but, rather a collection of changing international banking standards. In fact, the Basel Committee views these reforms as simply completing the Basel III Accord and contests the use of the unapproved term ‘Basel IV’. Irrespective of the terminology, significant new extensive requirements are being introduced by the Bank for International Settlements and Basel Committee of Banking Supervision. The key message is that Basel IV is being referred to as the most comprehensive transformation package in the history of the Basel regulations.