What Is Counterparty Credit Risk?

Counterparty credit risk refers to the risk of economic losses caused by the counterparty's failure to perform its obligations under the agreed contract.

Counterparty credit risk

The Basel Committee considers that for unsettled securities, commodities and foreign exchange transactions,

Counterparty credit risk includes

Over-the-counter derivatives and securities financing are the most typical examples of calculating counterparty credit risk. In accordance with the provisions of the Basel III, for the credit risk of counterparties in OTC derivatives and securities financing business, the standard method or internal model method can be selected to calculate the regulatory capital.

Taking the securities financing business included in the bank account as an example, the standard method is divided into a simple method and a comprehensive method. The former is also known as the risk weight substitution method, which uses the risk weight of the mortgage securities issuer to replace the counterparty risk weight, but the lower limit of the risk weight is 20%; the latter uses the following calculation formula:

Default exposure = max (0, E (1 + He) -C (1-Hc-Hfx))

Among them, E represents the exposure amount; He is the applicable regulatory discount factor; C is the value of the collateral; Hc is the discount factor applicable to the collateral; Hfx is the currency mismatch coefficient. Among them, He, Hc, and Hfx are set by the Basel Committee to be globally unified or calculated according to the unified formula of the global banking industry.

If the bank uses the internal model method to calculate the regulatory capital of the credit risk of securities financing business, it is required to calculate the value-at-risk at 5-day 99% confidence level. In terms of qualitative factors, regulatory requirements are set for the model.

Take the over-the-counter derivative transactions included in the bank account as an example. One method is the current exposure method. The default exposure calculation method is still in accordance with the 1988 old agreement model, that is,

Current exposure + add-on × nominal amount

Just a few modifications on additional factors. There is also a more complex internal model method, also known as the expected positive value exposure method.