The Non-Internal Model Method for Counterparty Credit Risk

Michael Pykhtin

counterparty-book

Basel II (Basel Committee on Banking Supervision 2006) provides three methods for calculating exposure at default (EAD) for counterparty credit risk (CCR). Banks that use advanced risk management and exposure modelling practices can apply to their national supervisors for permission to use the internal model method (IMM) for determining EAD. Unless a bank has supervisory permission to use the IMM (we shall call such banks IMM banks), it must use one of the two non-model methods: the Current Exposure Method (CEM) or the Standardised Method (SM). Some jurisdictions (including the US) do not permit the SM and only allow the CEM as a single non-model method. In jurisdictions that allow both methods, most non-IMM banks have chosen to use the CEM.

Basel III has introduced numerous enhancements to treatment of CCR (for details, see Chapter 1 in this volume). In particular, the area of applicability of the non-model methods has expanded. Under Basel III, all banks must use a non-internal method for calculating minimum capital requirements for exposure to central counterparties (CCPs)11See Basel Committee on Banking Supervision (2013c). and for calculating leverage ratio22See Basel Comm

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