The European Central Bank (ECB) today published the finalised guide outlining the methodology it uses to assess how euro area banks calculate their exposure to counterparty credit risk (CCR) and advanced credit valuation adjustment (CVA) risk, following a public consultation which ended on 18 March 2020.
These two risk types arise in derivatives trading and in transactions where securities are used to borrow or lend cash, such as repurchase agreements. Both activities entail the possibility that the counterparty may default. The global financial crisis has shown this to be one of the key financial risks a bank faces, since counterparty defaults can unleash systemic effects.
Under European Union law, banks are allowed to use internal models to calculate the value of their exposures to CCR and CVA risk as long as these models meet regulatory requirements. The guide published today explains the methodology the ECB uses to assess the validity of such models, especially in internal model investigations.
The text is also relevant when banks apply to extend or make changes to their models as well as for the ECB’s ongoing monitoring of such models.
The guide should not be construed as going beyond the currently applicable European Union and national laws and is therefore not intended to replace, overrule or affect said laws.
The ECB has given due consideration to all comments received during the consultation period and has published a feedback statement on its banking supervision website.