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Basel ii Accord Sections 182 to 190

(iii) The simple approach
 
Minimum conditions
 
182. For collateral to be recognised in the simple approach, the collateral must be
pledged for at least the life of the exposure and it must be marked to market and revalued
with a minimum frequency of six months.
 
Those portions of claims collateralised by the market value of recognised collateral receive the risk weight applicable to the collateral instrument. The risk weight on the collateralised portion will be subject to a floor of 20% except under the conditions specified in paragraphs 183 to 185. The remainder of the claim should be assigned to the risk weight appropriate to the counterparty.
 
A capital requirement will be applied to banks on either side of the collateralised transaction: for example, both repos and reverse repos will be subject to capital requirements.
 
Exceptions to the risk weight floor
 
183. Transactions which fulfil the criteria outlined in paragraph 170 and are with a core
market participant, as defined in 171, receive a risk weight of 0%. If the counterparty to the
transactions is not a core market participant the transaction should receive a risk weight of
10%.
 
184. OTC derivative transactions subject to daily mark-to-market, collateralised by cash
and where there is no currency mismatch should receive a 0% risk weight. Such transactions
collateralised by sovereign or PSE securities qualifying for a 0% risk weight in the
standardised approach can receive a 10% risk weight.
 
185. The 20% floor for the risk weight on a collateralised transaction will not be applied
and a 0% risk weight can be applied where the exposure and the collateral are denominated
in the same currency, and either:
 
• the collateral is cash on deposit as defined in paragraph 145 (a); or
 
• the collateral is in the form of sovereign/PSE securities eligible for a 0% risk weight,
and its market value has been discounted by 20%.
 
(iv) Collateralised OTC derivatives transactions
 
186. Under the Current Exposure Method, the calculation of the counterparty credit risk
charge for an individual contract will be as follows:
 
counterparty charge = [(RC + add-on) – CA] x r x 8%
where:
 
RC = the replacement cost,
 
add-on = the amount for potential future exposure calculated under the 1988
Accord,
 
CA = the volatility adjusted collateral amount under the comprehensive
approach prescribed in paragraphs 147 to 172, or zero if no eligible
collateral is applied to the transaction, and
 
r = the risk weight of the counterparty.
 
187. When effective bilateral netting contracts are in place, RC will be the net
replacement cost and the add-on will be ANet as calculated under the 1988 Accord. The
haircut for currency risk (Hfx) should be applied when there is a mismatch between the
collateral currency and the settlement currency.
 
Even in the case where there are more than two currencies involved in the exposure, collateral and settlement currency, a single haircut assuming a 10-business day holding period scaled up as necessary depending on the frequency of mark-to-market will be applied.
 
187 (i). As an alternative to the Current Exposure Method for the calculation of the
counterparty credit risk charge, banks may also use the Standardised Method and, subject to supervisory approval, the Internal Model Method as set out in Annex 4 of this Framework.
 
4. On-balance sheet netting
 
188. Where a bank,
 
(a) has a well-founded legal basis for concluding that the netting or offsetting agreement
is enforceable in each relevant jurisdiction regardless of whether the counterparty is
insolvent or bankrupt;
 
(b) is able at any time to determine those assets and liabilities with the same
counterparty that are subject to the netting agreement;
 
(c) monitors and controls its roll-off risks; and
 
(d) monitors and controls the relevant exposures on a net basis,
 
it may use the net exposure of loans and deposits as the basis for its capital adequacy
calculation in accordance with the formula in paragraph 147. Assets (loans) are treated as
exposure and liabilities (deposits) as collateral. The haircuts will be zero except when a
currency mismatch exists.
 
A 10-business day holding period will apply when daily mark-tomarket is conducted and all the requirements contained in paragraphs 151, 169, and 202 to  205 will apply.
 
5. Guarantees and credit derivatives
 
(i) Operational requirements
 
Operational requirements common to guarantees and credit derivatives 189. A guarantee (counter-guarantee) or credit derivative must represent a direct claim on the protection provider and must be explicitly referenced to specific exposures or a pool of exposures, so that the extent of the cover is clearly defined and incontrovertible.
 
Other than non-payment by a protection purchaser of money due in respect of the credit protection contract it must be irrevocable; there must be no clause in the contract that would allow the protection provider unilaterally to cancel the credit cover or that would increase the effective cost of cover as a result of deteriorating credit quality in the hedged exposure. (54) It must also be unconditional; there should be no clause in the protection contract outside the direct control of the bank that could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original counterparty fails to make the payment(s) due.
 
Additional operational requirements for guarantees
 
(54) Note that the irrevocability condition does not require that the credit protection and the exposure be maturity matched; rather that the maturity agreed ex ante may not be reduced ex post by the protection provider. Paragraph 203 sets forth the treatment of call options in determining remaining maturity for credit protection.
 
190. In addition to the legal certainty requirements in paragraphs 117 and 118 above, in
order for a guarantee to be recognised, the following conditions must be satisfied:
 
(a) On the qualifying default/non-payment of the counterparty, the bank may in a
timely manner pursue the guarantor for any monies outstanding under the
documentation governing the transaction.
 
The guarantor may make one lump sum payment of all monies under such documentation to the bank, or the guarantor may assume the future payment obligations of the counterparty covered by the guarantee.
 
The bank must have the right to receive any such payments from the guarantor without first having to take legal actions in order to pursue the counterparty for payment.
 
(b) The guarantee is an explicitly documented obligation assumed by the guarantor.
 
(c) Except as noted in the following sentence, the guarantee covers all types of
payments the underlying obligor is expected to make under the documentation
governing the transaction, for example notional amount, margin payments etc.
 
Where a guarantee covers payment of principal only, interests and other
uncovered payments should be treated as an unsecured amount in accordance
with paragraph 198.
 
Additional operational requirements for credit derivatives 191. In order for a credit derivative contract to be recognised, the following conditions must be satisfied:
 
(a) The credit events specified by the contracting parties must at a minimum cover:
 
• failure to pay the amounts due under terms of the underlying obligation that are
in effect at the time of such failure (with a grace period that is closely in line with
the grace period in the underlying obligation);
 
• bankruptcy, insolvency or inability of the obligor to pay its debts, or its failure or
admission in writing of its inability generally to pay its debts as they become due,
and analogous events; and
 
• restructuring of the underlying obligation involving forgiveness or postponement
of principal, interest or fees that results in a credit loss event (i.e. charge-off,
specific provision or other similar debit to the profit and loss account). When
restructuring is not specified as a credit event, refer to paragraph 192.
 
(b) If the credit derivative covers obligations that do not include the underlying
obligation, section (g) below governs whether the asset mismatch is permissible.
 
(c) The credit derivative shall not terminate prior to expiration of any grace period
required for a default on the underlying obligation to occur as a result of a failure
to pay, subject to the provisions of paragraph 203.
 
(d) Credit derivatives allowing for cash settlement are recognised for capital
purposes insofar as a robust valuation process is in place in order to estimate
loss reliably. There must be a clearly specified period for obtaining post-creditevent
valuations of the underlying obligation. If the reference obligation specified
in the credit derivative for purposes of cash settlement is different than the
underlying obligation, section (g) below governs whether the asset mismatch is
permissible.
 
(e) If the protection purchaser’s right/ability to transfer the underlying obligation to
the protection provider is required for settlement, the terms of the underlying
obligation must provide that any required consent to such transfer may not be
unreasonably withheld.
 
(f) The identity of the parties responsible for determining whether a credit event has
occurred must be clearly defined. This determination must not be the sole
responsibility of the protection seller. The protection buyer must have the
right/ability to inform the protection provider of the occurrence of a credit event.
 
(g) A mismatch between the underlying obligation and the reference obligation
under the credit derivative (i.e. the obligation used for purposes of determining
cash settlement value or the deliverable obligation) is permissible if
 
(1) the reference obligation ranks pari passu with or is junior to the underlying
obligation, and
 
(2) the underlying obligation and reference obligation share the
same obligor (i.e. the same legal entity) and legally enforceable cross-default or
cross-acceleration clauses are in place.
 
(h) A mismatch between the underlying obligation and the obligation used for
purposes of determining whether a credit event has occurred is permissible if
 
(1) the latter obligation ranks pari passu with or is junior to the underlying obligation,
and
 
(2) the underlying obligation and reference obligation share the same obligor (i.e. the same legal entity) and legally enforceable cross-default or crossacceleration clauses are in place.
   
 

 

 

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