How is counterparty risk measured?
Counterparty risk measures assess current and future exposure, but Monte Carlo simulation is typically required. Just as value at risk (VaR) is used to estimate market risk of a potential loss, potential future exposure (PFE) is used to estimate the analogous credit exposure in a credit derivative.
What is the major feature in Basel II capital requirements?
Minimal capital requirements play the most important role in Basel II and obligate banks to maintain minimum capital ratios of regulatory capital over risk-weighted assets.
How do you determine counterparty credit risk exposure?
A typical method for bilateral credit adjustments when only one of the two counterparties has a credit exposure is to compute the market value of the credit risk by adding up the discounted risk-neutral mean default loss, period by period, over the life of the positions between these two counterparties.
What is the minimum capital adequacy ratio under Basel II?
8%
Currently, the minimum ratio of capital to risk-weighted assets is 8% under Basel II and 10.5% under Basel III.
What is credit counterparty risk?
Counterparty risk is the probability that the other party in an investment, credit, or trading transaction may not fulfill its part of the deal and may default on the contractual obligations.
What is the difference between credit risk and counterparty credit risk?
Credit risk is the risk for holding a risky bond. Counterparty risk is the risk that the counterparty will not be able to meet its contractual obligations if the credit event occur.
Which risks are categorized as operational risk under Basel II?
The Basel Committee defines operational risk in Basel II and Basel III as: The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.
How is credit exposure calculated?
The credit exposure is therefore the sum of all open items, billable items and billed items of the business partner that are not yet invoiced. Contract Accounts Receivable and Payable transfers only those billable and billed, but not yet invoiced, items that you have created for billing in postpaid scenarios.
What is its minimum required capital requirement under Basel II?
Under Basel II, banks are required to maintain a total capital ratio (Tier 1 + 2 + 3) of minimum 8%. Banks must hold 4% of Tier 1 capital of which a minimum core capital ratio of 2%.
What type of risk is counterparty risk?
Counterparty risk is also known as default risk. Default risk is the chance that companies or individuals will be unable to make the required payments on their debt obligations. Lenders and investors are exposed to default risk in virtually all forms of credit extensions.
How is counterparty risk covered in Basel III?
The risk of counterparty default was already covered in Basel I and Basel II. The Basel III reforms introduced a new capital charge for the risk of loss due to the deterioration in the creditworthiness of the counterparty to a derivatives transaction or an SFT.
How is CCR treated in the Basel III framework?
CCR is a complex risk to assess. It is a hybrid between credit and market risk and depends on both changes in the creditworthiness of the counterparty and movements in underlying market risk factors. This Executive Summary provides an overview of the treatment of CCR in the Basel III framework.
How are banks required to calculate counterparty credit risk?
Banks are required to identify their transactions that expose them to counterparty credit risk and calculate a counterparty credit risk charge. This chapter starts by explaining the definition of counterparty credit risk.
What are the minimum requirements for Basel 2?
Under Basel II, banks are required to maintain a total capital ratio (Tier 1 + 2 + 3) of minimum 8%.