On Credit Valuation Adjustments and Regulatory Capital

Henry Wayne

Basel III is a collection of regulatory reforms issued by the Basel Committee on Banking Supervision in 2010 and revised in June 2011 (Basel Committee on Banking Supervision 2011) with a set of explicit goals in mind:

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  to raise the amount and quality of capital, with a focus on the full absorption of loss in times of stress;

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  to require the effective provisioning of readily available liquidity to ensure banks can survive near-term shocks to their sources of funds;

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  to limit the amount of leverage a firm can generate from its capital base, in addition to limiting the opportunity for non-regulated sectors to systemically leverage regulated balance sheets;

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  to create a framework for more consistent and effective supervision of firms.

In this chapter, we look at just one core component of this regulatory reform agenda: the inclusion of an explicit regulatory capital charge against potential losses arising from the unhedged movement of the credit valuation adjustment (CVA). We shall look at the history and development of the charge, the background that led to its development and the conclusions (the global implementation was largely completed