DATE: 01 June 2011
Today the Basel Committee on Banking Supervision announced that it has completed its review of and finalised the Basel III capital treatment for counterparty credit risk in bilateral trades. The review resulted in a minor modification of the credit valuation adjustment, which is the risk of loss caused by changes in the credit spread of a counterparty due to changes in its credit quality (also referred to as the market value of counterparty credit risk).
Under Basel II, the risk of counterparty default and credit migration risk were addressed but mark-to-market losses due to credit valuation adjustments (CVA) were not. During the financial crisis, however, roughly two-thirds of losses attributed to counterparty credit risk were due to CVA losses and only about one-third were due to actual defaults.
The Basel III framework, published in December 2010, sets out capital rules for CVA risk that include standardised and advanced methods. At the time it issued Basel III, the Committee noted that the level and reasonableness of the standardised CVA risk capital charge was subject to a final impact assessment targeted for completion in the first quarter of 2011.
The impact study has been completed. It showed that the standardised method as originally set out in the December 2010 rules text could be unduly punitive for low-rated counterparties with long maturity transactions. To narrow the gap between the capital required for CCC-rated counterparties under the standardised and the advanced methods, the Basel Committee agreed to reduce the weight applied to CCC-rated counterparties from 18% to 10%.
All other aspects of the regulatory capital treatment for counterparty credit risk and CVA risk remain unchanged from the December 2010 Basel III rules text. Overall, the Committee estimates that, with the addition of the CVA risk capital charge, the capital requirements for counterparty credit risk under Basel III will double the level required under Basel II (ie when counterparty credit risk was capitalised for default risk only). A revised version of the Basel III capital rules reflecting the CVA modification is now available.
The Committee is in the process of completing its review of capitalisation of bank exposures to central counterparties (CCPs) and expects to finalise its December 2010 proposals before year end.
NOTES:
The Basel Committee on Banking Supervision consists of senior representatives of bank supervisory
authorities and central banks from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany,
Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi
Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United
States. It usually meets at the Bank for International Settlements (BIS) in Basel, Switzerland, where its
permanent Secretariat is located. [Basel III]
The Basel Committee is raising the resilience of the banking sector by strengthening the regulatory capital framework, building on the three pillars of the Basel II framework. The reforms raise both the quality and quantity of the regulatory capital base and enhance the risk coverage of the capital framework. They are underpinned by a leverage ratio that serves as a backstop to the risk-based capital measures, is intended to constrain excess leverage in the banking system and provide an extra layer of protection against model risk and measurement error. Finally, the Committee is introducing a number of macroprudential elements into the capital framework to help contain systemic risks arising from procyclicality and from the interconnectedness of financial institutions. [Basel III]
The Basel III framework is a central element of the Basel Committee’s response to the global financial crisis. It addresses a number of shortcomings in the pre-crisis regulatory framework and provides a foundation for a resilient banking system that will help avoid the build-up of systemic vulnerabilities. The framework will allow the banking system to support the real economy through the economic cycle. This document, originally published in December 2010 and updated in June 2011 (to reflect a minor modification to the credit valuation adjustments applied to address counterparty credit risk in bilateral trades) represents the initial phase of Basel III reforms. [BIS Documentation]
This document, together with the document Basel III: International framework for liquidity risk measurement, standards and monitoring, presents the Basel Committee’s reforms to strengthen global capital and liquidity rules with the goal of promoting a more resilient banking sector. The objective of the reforms is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. This document sets out the rules text and timelines to implement the Basel III framework.