Credit Risk Equivalence

Credit Risk Equivalence
The existence of diversification activities of the bank, the higher the need to calculate the ekposure on off-balance sheet. Generally off balance sheet liabilities is kontinjen such as guarantees, options, acceptance, warranties. No cash or physical assets to show the value in the balance sheet. Balance does not record the contract, only to record the results. Example: the contract of insurance is listed → premium must be paid, not a contract.
Basel Committee to introduce the concept of credit risk equivalence in March 1986 in a paper entitled "The Management of Banks' Off-Balance-Sheet Exposures: A Supervisory Perspective."
The concept of credit risk equivalence is' each transaction off-balance-sheet can be converted into equivalent loan so that it can be inserted into the on-balance-sheet to calculate the RWA. This ensures that the definition includes all obligations RWA bank not only asset-a loan or other asset.

Standard credit substitute instruments
List posts in the off-balance-sheet with a simple Conversion Factors (CF):
Instruments represent the general category and bank supervisors each country can add the instrument to a specific category.

Derivative Instruments → treated differently
Derivative instruments are financial transactions where the amount of principal is not exchanged. Price is determined from the value of one / more items below:
Financial instruments
Index
Commodity, or
Other derivative instruments

If the counterparty TORT, banks did not experience any loss of value of the swap contract, but only as potential cost to replace the cash flow equivalent of the contract (the credit equivalent). CF to mark-to-market Exposure is 50% of the CF table above.
Contracts and derivatives, among others:
Swaps and interest rate options, forward rate agreements, interest rate futures
exchange rate Swaps and options, forward foreign exchange contracts, currency futures (out of contract with maturity <14 days)
precious and non-precious Metals Swaps and options, forwards and futures contracts
Swaps equity and equity options and futures contracts
Two methods to calculate the credit equivalent of the contracts this:
The Current Exposure Method
The Original Exposure Method
(Two of this method does not reflect the Value at Risk Models → Var appear after the new Committee to publish the risk of changes in the market in 1996)


The Current Exposure Method → method chosen by the Basel I
This method is the current replacement cost of the contract with the mark-to-market according to market prices.
→ a simple process given that the market is a derivatives market which many are
→ this method is accurate and provide a clear comparison between the derivatives market and the loan equivalent of time
Value mark-to-market change continuously as the value of contracts is influenced by various factors, eg interest rate swap is very much dependent on the movement of interest rate related.
When the value of mark-to-market positive, indicating the value of the loss will be experienced by the bank when the counterparty TORT. However, because the value of mark-to-market fluctuates up to maturity, there is a risk that credit will be increased eksposure than the value of mark-to-market at this time.
A capital charge is applied to eksposure this by adding additional% of the notional principal value of the mark-to-market at this time.

The Original Exposure Method
This method allows the bank calculates% of the notional principal without the current value of the contract.
In Basel I banks permitted to use this method while the time while waiting diimplementasikannya Current Exposure Method. This is generally applied to banks have matched the position of small, but for banks that do forwards, Swaps, options purchased, etc. should use the Current Exposure Method.

Calculation of capital requirement
Capital needs RWA x is the minimum target capital ratio (8%)