BCBS: Application of own credit risk adjustments to derivatives - consultative document

Application of own credit risk adjustments to derivatives - Basel Committee consultative document
December 21, 2011
http://www.bis.org/press/p111221.htm

The Basel Committee today issued a consultative document on the application of own credit risk adjustments to derivatives.

The Basel III rules seek to ensure that a deterioration in a bank's own creditworthiness does not at the same time lead to an increase in its common equity as a result of a reduction in the value of the bank's liabilities. Paragraph 75 of the Basel III rules requires a bank to "[d]erecognise in the calculation of Common Equity Tier 1, all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank's own credit risk".

The application of paragraph 75 to fair valued derivatives is not straightforward since their valuations depend on a range of factors other than the bank's own creditworthiness. The consultative paper proposes that debit valuation adjustments (DVAs) for over-the-counter derivatives and securities financing transactions should be fully deducted in the calculation of Common Equity Tier 1. It briefly reviews other options for applying the underlying concept of paragraph 75 to these products and the reasons these alternatives were not supported by the Basel Committee.

The Basel Committee welcomes comments on all aspects of this consultative document by Friday 17 February 2012. Comments should be sent to baselcommittee@bis.org. Alternatively, comments may be submitted to the following address: Basel Committee on Banking Supervision, Bank for International Settlements, Centralbahnplatz 2, 4002 Basel, Switzerland. All comments may be published on the BIS website unless a commenter specifically requests confidential treatment.


Summary (http://www.bis.org/publ/bcbs214.htm, edited):

A deterioration in a bank's own creditworthiness can lead to an increase in the bank's common equity as a result of a reduction in the value of its liabilities. The Basel III rules seek to prevent this. Paragraph 75 of the Basel III rules requires a bank to "[d]erecognise in the calculation of Common Equity Tier 1, all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank's own credit risk". The application of paragraph 75 to fair valued derivatives is not straightforward since their valuations depend on a range of factors other than the bank's own creditworthiness. The consultative paper proposes that debit valuation adjustments (DVAs) for over-the-counter derivatives and securities financing transactions should be fully deducted in the calculation of Common Equity Tier 1. It briefly reviews other options for applying the underlying concept of paragraph 75 to these products and the reasons these alternatives were not supported by the Basel Committee.

PDF: http://www.bis.org/publ/bcbs214.pdf