Credit valuation adjustment capital charge under basel III on interest rate swap

Abstract

This thesis aims to provide an overview of Credit Valuation Adjustment (CVA) Capital Charge introduced in Basel III together with its importance for banks’ solvency position and the illustration of computing CVA capital. The Basel Committee on Banking Supervision (BCBS) proposed this new capital requirement to guarantee the solvency of banks against the deterioration in their counterparties’ creditworthiness on over-the-counter derivatives contracts after the crash of the global financial system in 2008. In the previous regulation, Basel II, the Counterparty Credit Risk (CCR) only includes the Default Risk and hence it did not capture the CVA Risk - one of the main factors causing the Financial Crisis 2008. The thesis only puts more emphasis on the CVA capital requirement for Interest Rate Swap (IRS). Two methods for calculating CVA capital are mentioned: the Standardized model and the Advanced model, but only the former is illustrated. The data used for computing the capital is based on simulation because these are confidential contracts. In addition, this thesis assumes the Exposure at Default and the Effective Maturity are available for use. Key words: Credit Valuation Adjustment, CVA capital charge, Basel III, Basel II, Counterparty Credit Risk, Interest Rate Swap, Exposure at Default, Effective Maturity.