Context:
The Reserve Bank of India (RBI) has proposed to widen the scope of capital charge for Counterparty Credit Risk (CCR) to include derivatives in equity, precious metals (excluding gold), and other commodities.
Key Highlights:
- Current Coverage: CCR norms currently apply to interest rate contracts, exchange rate contracts, and derivatives.
- Proposed Changes:
- Inclusion of equity derivatives, precious metals (except gold), and commodity derivatives under CCR.
- Specification of credit conversion factors (CCF) to ensure adequate capital provisioning for such exposures.
- Objective:
- Align with Basel Committee on Banking Supervision (BCBS) guidelines.
- Reflect market developments since the last revision in August 2008.
- Impact on Banks:
- Clearing members of SEBI-recognised stock exchanges in equity and commodity derivatives must maintain capital charge for CCR.
Counterparty Credit Risk (CCR)
Counterparty Credit Risk (CCR) is the risk that the other party in a financial transaction (the counterparty) may fail to meet its obligations before the final settlement of the transaction. It is most common in derivatives, securities financing, and trading transactions.
Key Features of CCR:
- Arises in: Derivatives (like swaps, options, futures), securities lending, and repo transactions.
- Different from Regular Credit Risk:
- Credit Risk: Risk of borrower default on a loan.
- CCR: Risk that a trading partner defaults during the life of the contract, not just at maturity.
- Two Types of Loss:
- Replacement Cost: Loss if the counterparty defaults and the contract must be replaced at current market prices.
- Potential Future Exposure (PFE): Possible future loss due to market volatility over the life of the contract.
Why It Matters?
- For Banks: Impacts capital adequacy; they must maintain sufficient capital to cover CCR.
- Regulation:
- Basel Committee on Banking Supervision (BCBS): Provides global standards for CCR capital charges.
- RBI: Aligning Indian rules with Basel norms (recently proposed expansion to include equity, precious metals except gold, and other commodity derivatives).
