Capital Buffers and Risk-weighted Assets Under Basel III - METAC

RWA: COUNTERPARTY RISK• Counterparty risk: EAD (as an item of information)Current exposure method Standardized method Internal modelling to estimateEADMethod EAD is the currentreplacement cost (RC) morean add-onEAD = RC + add-onUnder this method, banksmust calculate the currentreplacement cost by markingcontract to market, thuscapturing the currentexposure without any needfor estimation, and adding afactor (“the add-on”) to reflectthe potential future exposureover the remaining live of thecontract.Add-on for single name creditderivatives (notional amount xcoefficients set in para 707).See para 708 Basel II for n-to-default credit derivativeprudential treatment.EAD is the max of:• the sum of current netmarket value and• the sum of absolutevalues of net riskpositions i (notionalamount times modifiedduration) compensatedwith other positions foreach maturity bucket andthen multiplied by a creditconversion factor (0.3%for credit default swap)Multiplied by a coefficient β=1,4EAD is calculated as theproduct of alpha timeseffective EPE:EAD = α x effective EPEEffective expected positiveexposure is the weightedaverage over time of effectiveexpected exposure over thefirst year (differently ifcontracts mature before oneyear). Therefore banks haveto specify the forecastingdistribution for changes in themarket value to the changesin market variables.α= 1,4 or higher at thediscretion of the supervisor.The use of internal modellingis subject to prior validationby the bank’s supervisor.Source: Author’s own; BCBS30