Basel committee reduces weight on counterparties to just 10%

MANILA, Philippines - The Basel Committee on Banking Supervision has agreed to reduce the weight applied to CCC-rated counterparties from 18 percent to 10 percent.

That was the feedback received after the committee conducted a review on the Basel III capital treatment for counterparty credit risk in bilateral trades.

The Basel Committee on Banking Supervision is a working committee of the Bank for International Settlements (BIS), often referred to as the world’s central bank. The BIS, through the said committee, issues international banking regulations, frameworks and structures that serves as guidelines for the international banking community.

Recently, the committee said it had completed its review of and finalized 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 standardized and advanced methods.

At the time it issued Basel III, the committee noted that the level and reasonableness of the standardized 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,” the committee said in a statement.

It showed that the standardized 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 standardized and the advanced methods, the Basel Committee agreed to reduce the weight applied to CCC-rated counterparties from 18 percent to 10 percent,” it added.

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 (i.e., when counterparty credit risk was capitalized for default risk only).

It is also in the process of completing its review of capitalization of bank exposures to central counterparties (CCPs) and expects to finalize its December 2010 proposals.

The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.

The committee is best known for its international standards on capital adequacy; the Core Principles for Effective Banking Supervision; and the Concordat on cross-border banking supervision. Its members come from representatives of the central banks of: 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. The present chairman of the committee is Nout Wellink, president of the Netherlands Bank.