Basel
ii in the United States of America
From the
Basel ii
Compliance Professionals Association (BCPA),
the largest association of Basel ii Professionals in the
world
Final Rule, USA: Risk-Based Capital Standards:
Advanced Capital Adequacy Framework — Basel II
Nth–to-default
credit derivatives
Credit derivatives that
provide credit
protection only for the nth
defaulting reference exposure in a group
of reference
exposures (nth-to-default
credit derivatives) are similar to synthetic securitizations that
provide credit protection only after the first-loss tranche has defaulted or become a loss.
A
simplified treatment is available to banks that purchase and provide such credit
protection.
A bank that obtains credit protection on a
group of underlying exposures through a
first-to-default credit derivative must determine its risk-based capital requirement for the
underlying exposures as if the bank had
synthetically securitized only the
underlying exposure with the lowest capital requirement and had obtained no credit risk mitigant
on the other (higher capital requirement) underlying
exposures.
If the
bank purchases credit protection on a group of underlying exposures through an nth-to-default
credit derivative (other than a first-to-default credit derivative), it may only recognize the
credit protection for risk-based capital purposes either if it has obtained credit
protection on the same underlying exposures in the form of first-through-(n-1)-to-default credit
derivatives, or if n-1 of the underlying exposures have already defaulted.
In such a case,
the bank must again determine its risk-based capital requirement for the underlying
exposures as if the bank had only synthetically securitized the n – 1 underlying exposures
with the lowest capital requirement and had obtained no credit risk mitigant on the
other underlying exposures.
A bank that provides credit protection on
a group of underlying exposures through a first-to-default credit derivative must
determine its risk-weighted asset amount for the derivative by applying the RBA (if the
derivative qualifies for the RBA) or, if the derivative does not qualify for the RBA,
by setting its risk-weighted asset amount for the derivative
equal to the product of
(i) the
protection amount of the derivative;
(ii)
12.5; and
(iii)
the sum of the risk-based capital requirements of the
individual underlying exposures, up to a maximum of 100
percent.
If a
bank provides credit protection on a group of underlying exposures through an nth-to-default
credit derivative (other than a first-to-default credit derivative), the
bank must determine its risk-weighted asset amount for the derivative by applying the RBA (if
the derivative qualifies for the RBA) or, if the derivative does not qualify for the RBA,
by setting the risk-weighted asset amount for the derivative equal to the product of
(i) the
protection amount of the derivative;
(ii) 12.5; and
(iii) the sum of the risk-based
capital requirements of the individual underlying exposures (excluding the n-1 underlying
exposures with the lowest risk-based capital requirements), up to a maximum of 100
percent.
For example, a bank provides credit
protection in the form of a second-to-default credit
derivative on a basket of five reference exposures.
The
derivative is unrated and the protection amount of the
derivative is $100.
The
risk-based capital requirements of the underlying exposures are 2.5 percent,
5.0 percent, 10.0 percent, 15.0 percent, and 20 percent. The risk-weighted asset amount of
the derivative would be $100 x 12.5 x (.05 +
.10 + .15 + .20) or $625.
If the
derivative were externally rated in the lowest investment grade rating category with a positive
designation, the risk-weighted asset amount would be $100 x 0.50 or $50.
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