If exposures have been guaranteed by certain third parties, this may result in mitigation of the capital requirements subject to certain conditions. The list of eligible guarantors (providers of unfunded credit protection) is limited and includes central governments and financial undertakings. Parent undertakings, subsidiaries and related group entities are recognised if their credit quality is sufficiently high.
Double-default treatment of unfunded credit protection
The likelihood that both the original obligor and the guarantor will default is smaller than the likelihood is that one of them will default. The double-default treatment takes account of this. Financial undertakings that apply the IRB may adopt this approach subject to certain conditions. The protection provider must be a financial undertaking, insurer, reinsurer or export credit agency that has sufficiently high credit quality and expertise. Credit protection which is provided by an export credit agency and is subject to a counter-guarantee of a central government body is not eligible for the double-default approach.
Eligible types of credit derivative
The following types of credit derivative are designated as eligible credit protection subject to certain conditions:
- credit default swaps
- total return swaps, and
- credit-linked notes to the extent of their cash funding.
Instruments consisting of a combination of these types of credit derivative or instruments that are comparable in terms of their economic effect are also eligible.
Subject to certain conditions, a guarantee backed by a counter guarantee from a government body, central bank or public law entity with a 0% risk weight may also be taken into account. Such a counter guarantee must meet the same requirements as a direct guarantee, except for the requirement that it should be a direct guarantee.
Requirements for guarantees and credit derivatives
To be eligible, guarantees and credit derivatives must fulfil various conditions, including the following:
- they must provide direct credit protection;
- the protection provider may not unilaterally terminate the protection;
- the costs of the protection borne by the protection buyer do not increase if the credit quality of the protected exposure deteriorates;
- the protection provider is obliged to pay as quickly as possible if the original obligor fails to make any payments that are owed.
Calculations of the risk-weighted assets and off-balance sheet items
|The adjusted value of the guarantee (GA):|
|GA =||G x (1-Hfx) x (t – 0,25)/(T – 0,25)|
|G =||nominal amount of the credit protection|
|Hfx =||volatility adjustment for any currency mismatch calculated in accordance with the supervisory authority method or own estimate method under the financial collateral comprehensive method.|
|(t – 0,25)/(T – 0,25) =||adjustment for any maturity mismatch|
|Calculation for the standardised approach:|
|RWA =||the off-balance sheet risk-weighted assets and items|
|RWA =||(E-GA) x r + GA x g|
|E =||value of the exposure|
|r =||risk weight of claims against the original obligor under the standardised approach|
|g =||risk weight of claims against the protection giver under the standardised approach|
|Calculation for the Foundation Internal Ratings Based Approach: |
The PD of the guarantor and the LGD of the guarantee are used for the part of the exposure covered by the guarantee. For the unsecured part the PD of the borrower and the LGD of the underlying exposure are used.
Credit-linked notes issued by the financial undertaking are treated as cash collateral. On this subject see CRM– Credit Risk Mitigation by means of Financial Collateral.