New approach for measuring counterparty credit risk exposures finalised by the Basel Committee

31 March 2014

The Basel Committee has today published a final standard on the treatment of derivatives-related transactions in its capital adequacy framework.

The standardised approach for measuring counterparty credit risk exposures improves on existing non-modelled methodologies for assessing the counterparty credit risk associated with derivative transactions. The standardised approach therefore replaces both the Current Exposure Method and the Standardised Method in the Basel capital framework. It also simplifies the framework by narrowing the range of methodologies available to banks in measuring their counterparty credit risk exposures.

The Committee's aim was to develop a risk-sensitive methodology that appropriately differentiates between margined and unmargined trades, and provides a more meaningful recognition of netting benefits than either of the existing non-modelled approaches.

The new approach reduces the need for discretion by national authorities, limits the use of banks' internal estimates, and avoids undue complexity by drawing upon prudential approaches already available in the capital framework. It is calibrated to reflect the volatilities observed over the recent stress period, while also taking account of incentives for centralised clearing of derivative transactions.

The new approach gives regard to the feedback received from respondents to the Basel Committee's consultative paper The non-internal model method for capitalising counterparty credit risk exposures, and the results of a related quantitative impact study. In the light of this information, a number of adjustments were made to the methodology outlined in the consultative paper, which include:

  • increased specificity on the application of the approach to complex instruments;
  • the introduction of a supervisory measure of duration for interest rate and credit derivative exposures;
  • removal of the one-year trade maturity floor for unmargined trades and the addition of a formula to scale down the maturity factor for any such trades with remaining maturities of less than one year; and
  • adjustments to the calibration of the approach with respect to foreign exchange, credit and some commodity derivatives.

The standardised approach for counterparty credit risk will take effect from 1 January 2017. Given the approach's enhanced risk sensitivity, the Basel Committee has also agreed to eliminate the use of the "IMM shortcut method" for measuring counterparty exposures once the new standardised approach takes effect.

Stefan Ingves, Chairman of the Basel Committee and Governor of Sveriges Riksbank, said "the standardised approach for counterparty credit risk represents an important milestone in the Committee's post-crisis overhaul of the capital framework. It also shows the Committee's commitment to simplifying the framework by ushering in a single standardised approach that will be complemented by a single modelled approach in this area."