CVA Risk Capital: RBI’s Draft Revised Framework for Banks
Why in the news
The RBI released a draft to overhaul how banks hold capital against the chance that a derivative counterparty defaults. Comments are open until 28 August, and the rules would apply from 1 April 2027.
Key facts
- Subject: capital requirement for Credit Valuation Adjustment (CVA) risk, replacing norms that date from 2011.
- Applies to: commercial banks, but not small finance banks, payments banks or local area banks.
- Feedback deadline: 28 August; proposed start: 1 April 2027.
- Method: Basic Approach for CVA (BA-CVA), in a Reduced or Full version.
- Shortcut threshold: aggregate notional of non-centrally cleared derivatives up to ₹10 trillion.
The two BA-CVA versions
| Version | Hedges | Fits |
|---|---|---|
| Reduced BA-CVA | No hedge is recognised | Banks that leave this risk unhedged |
| Full BA-CVA | Eligible hedges count, e.g. single-name and index credit default swaps, if conditions tie the hedge to the counterparty | Banks that hedge CVA risk actively |
Simplified option for smaller books
- Skip the BA-CVA calculation altogether and set the CVA requirement at 100% of the counterparty credit risk capital.
- No CVA hedges may be recognised under this route.
- RBI’s supervisory arm may refuse the option if CVA risk is material to the bank’s overall profile.
Why the rules are changing
- The current rules rest on 2010 standards from the Basel Committee on Banking Supervision (BCBS).
- The BCBS later revised its guidance within the final Basel III framework, so RBI wants to align with global norms.
Concepts
- CVA: an adjustment to a derivative’s price reflecting the chance that the counterparty defaults; the capital charge covers losses from that risk.
- Counterparty credit risk: the other party defaults before settlement; exposure moves with the market.
- Central clearing: trades through a central counterparty such as the Clearing Corporation of India Ltd are safer, which is why the threshold counts only non-centrally cleared trades.
- Credit default swap: pays out if a named entity defaults, so it is an eligible hedge.
- Basel III: global post-2008 rules on capital adequacy, leverage and liquidity, set by the BCBS, hosted by the Bank for International Settlements.
Exam angle
- Full form: Credit Valuation Adjustment; approach: BA-CVA (Reduced or Full).
- Threshold: ₹10 trillion of non-centrally cleared derivatives.
- Standard setter: BCBS, which sits at the Bank for International Settlements.
- Flagged as highly relevant to RBI Grade B Phase II Paper III.