6.1 Counterparty Credit Risk

No: 341000015689

Date(g): 19/12/2012 | Date(h): 6/2/1434

Status: In-Force

As mentioned, Counterparty Credit Risk under Basel II only measured Default Risk which could be calculated by using the following 3 methods, where SAMA adopted the # 3 Current Exposure Method.
	1.	Internal Model Method
	2.	Standardized Approach
	3.	Current Exposure Method (CEM)
In this regard, SAMA had permitted only the Current Exposures Method under Basel II. For Basel III purposes as in Basel II banks are to use the more simple CEM.
Further, Basel III introduced the concept of Current Value Adjustment (CVA) as an additional Counterparty Risk, which again can be determined by using the Internal Model Method (IMM) or the Standardized Method.
It should also be emphasized that Basel III introduced incremental risk or additional risk through the concept of the Credit Value Adjustment which measure the counterparty risk prior to default. Consequently, total risk is an aggregate of these two.
The main revision to Internal Models Method to measure default risk exposure is to using the Effective EPE with stressed parameters.
In this regard, the Default risk capital charge is the greater of:
	•	Portfolio level capital charge based on effective EPE (not including CVA charge using current market data) and the portfolio level capital charge based on effective EPE under stress calibration.

B. Credit Value Adjustment

Capitalization of the risk of CVA losses

The major element of CVA include the following:
	•	Applies to IMM and non IMM banks
	•	Huge mark-to-market losses incurred during financial crisis
	•	BCBS introduced a ‘’bond equivalent of the counterparty exposure’’ approach which aims to better capture CVA losses
	•	In addition to default risk, additional capital charge introduced for CCR for OTC derivatives
	•	Transactions with SFTs and CCPs excluded from CVA capital charge unless these are material, where the materiality threshold for SFT’s will be defined by SAMA and if warranted, bank will be advised accordingly.
	•	Banks with IMM approval and Specific Interest Rate Risk VaR model approval for bonds will use ‘’Advanced CVA risk capital charge’’
	•	All other banks will calculate CVA capital charge based on ‘’Standardized CVA risk capital charge’’ methodology
	•	Under Basel II, Banks in KSA are mandated by SAMA to use ‘’CEM’’ methodology for both Standardized & IRB Approach. However, for Basel III they can utilize IMM as well.
	•	Under the Standardized Approach, Banks would be required to develop enhanced system’s capability to apply this formula
	•	Maturity: Mi is the notional weighted average maturity (FAQ- For CVA purposes, the 5-year cap of the effective maturity will not be applied). This applies to all transactions with the counterparty, not only to index CDS- Maturity will be capped at the longest contractual remaining maturity in the netting set.

A. Counterparty credit risk using Internal Models

This section is only applicable for those banks that have been given regulatory approval by SAMA to use the IMM Approach to calculate counterparty credit risk. Alternatively, Banks should use Standardized Approach 6.1.B on page 30. Also, for further clarifications, please refer to SAMA Circular # BCS 24331 dated 4 September 2012 entitled "Basel III Definition of Capital FAQs (p.7).