- Analyses how capital requirements for counterparty credit risk management vary depending on an institution’s business model
- Explores how to deal with counterparty credit risk in the current financial environment
- Studies the conditions for effective management of counterparty credit risk
Quantifi, a leading provider of analytics, trading and risk management solutions for the global OTC markets, has published a joint whitepaper with Risk Dynamics, entitled ‘Managing Counterparty Credit Risk – Capital Requirements for Retail, Commercial and Proprietary Portfolio Strategies’. This paper explores how to deal with counterparty credit risk in the current financial environment by detailing some of the associated aspects and challenges. It also studies the conditions for effective management of counterparty credit risk. In a joint effort, Quantifi and Risk Dynamics compare capital requirements, identify inconsistencies in prudential regulations and apply the various capital approaches on typical portfolio strategies observed within financial institutions.
There is currently a strong market focus on counterparty credit risk and more specifically on Credit Value Adjustment (CVA). The attention is predominantly towards the issue of efficient CVA pricing as opposed to implications in terms of risk management and capital requirements. However, since the recent crisis, another issue has gained prominence; the significant losses that counterparty credit risk can cause if not correctly managed.
“In this latest paper, we consider all possible combinations of regulatory capital charges, based on banks obtaining approval of internal models and processes. Depending on a bank’s structure, as well as the size and content of their portfolios, we demonstrate how certain strategies can reduce these charges.”Dmitry Pugachevsky, Director of Research at Quantifi
Dmitry Pugachevsky, Director of Research at Quantifi, states, “In the current regulatory environment, to correctly assess capital charges owing to counterparty credit risk, it is important to consistently combine both RWA Basel II and CVA VaR Basel III capital. In this latest paper, we consider all possible combinations of regulatory capital charges, based on banks obtaining approval of internal models and processes. Depending on a bank’s structure, as well as the size and content of their portfolios, we demonstrate how certain strategies can reduce these charges. However, in all instances, the approval of internal models and processes allows banks to adopt the advanced methods which are designed to provide greater capital relief.”
The paper reviews a number of key topics:
- Measuring the impact of different counterparty credit risk measurement methodologies based on typical portfolio strategies and the potential incentives of moving from one approach to the other
- Analysis of how portfolio strategies and capital requirements for counterparty credit risk management can vary substantially depending on an institutions’ business model. To capture these variations, the paper presents calculations of CVA for three different portfolios, different collateral strategies and different counterparty profiles
- The importance of measuring counterparty credit risk from a business, accounting, regulatory and risk management perspective
- Key challenges of modelling counterparty credit risk including implementation, efficiency and CVA management
Marc Taymans, Managing Partner at Risk Dynamics, states, “Taking into account all types of risks in a contract is of paramount importance for financial institutions to evaluate the effective returns they can expect from a deal. The key is to have a correct understanding and measurement of counterparty credit risk, not only from a pricing or regulatory perspective but from a risk management angle too. This can be achieved by identifying inconsistencies in regulatory requirements, creating different types of internal models (e.g. stress testing or economic capital models) and by acting efficiently on the management of portfolios based on these models.”
To request a copy of this latest whitepaper: