A Review of the Credit Valuation Adjustment Risk Framework is being undertaken by the Basel Committee. The objectives of the review are to (i) ensure that all important drivers of credit valuation adjustment (CVA) risk and CVA hedges are covered in the Basel regulatory capital standard; (ii) align the capital standard with the fair value measurement of CVA employed under various accounting regimes; and (iii) ensure consistency with the proposed revisions to the market risk framework under the Basel Committee’s Fundamental review of the trading book.
The Basel III capital framework already establishes a minimum capital charge to capture the potential mark-to-market losses faced by a bank from the deterioration in a counterparty’s creditworthiness. This capital treatment addresses any variability in CVA that arises due to changes in credit spreads but does not take account of variability arising from daily changes in market risk factors (ie account exposure variability).
This consultative paper envisages a CVA risk framework that takes into account the market risk exposure component of CVA along with its associated hedges. The regulatory capital requirement for CVA risk would be based on exposure models that banks also use to determine their accounting CVA, subject to conditions intended to reduce potential variability due to risk-weighted asset (RWA) calculations or remaining discrepancies in financial reporting practices across banks and jurisdictions.
For a broad range of internationally active banks, accounting CVA is fair-valued through the profit and loss (P&L) account and is sensitive to the same risk factors as instruments held in the trading book. The consultative paper therefore proposes an internal models approach and a standardised approach for CVA risk that have been adapted from the revised market risk framework under the Committee’s Fundamental review of the trading book. A basic approach for CVA risk is also proposed for banks that are less likely to regularly compute CVA sensitivities to a large set of market risk factors, owing to the nature of their trading operations. The consultation document can be found here.
