Counterparty Exposure Management in the Basel III Era

23 Pages Posted: 13 May 2012 Last revised: 27 Mar 2013

Date Written: June 1, 2011

Abstract

Financial institutions face many challenges due to recent Basel III-related changes in the area of counterparty exposure measurement and management. In response to these challenges, SAS delivers an integrated risk offering – SAS® Risk Management for Banking – that can meet the immediate requirements banks are looking for while providing a framework to support future business needs. In the wake of the recent credit crisis, with counterparty risk being widely thought of as the center of the credit crisis, it is not surprising that regulators demand a significantly higher market discipline in risk management of counterparty exposure under the heading of Basel III. The credit crisis, seeing the rescue of entities such as Bear Stearns, AIG, Fannie Mae and Freddie Mac – and the non-rescue of Lehman Brothers – led to significant losses in the market. Indeed most banks viewed these institutions as “too big to fail,” and, hence, exposures toward these institutions were viewed as risk-free. After the credit crisis, banks have been more actively focused on measuring, pricing and hedging counterparty risk. The regulators have also called for a new regulation because of the significant losses experienced due to counterparty risk and because of their observance of insufficient bank practices in validating and stress testing counterparty exposure. This paper puts in perspective the counterparty exposure management processes that banks need to implement to address the new Basel III era of counterparty exposure regulation. Its key components are exposure measurement – taking into account netting and collateral, mark to market, hedging and regulatory value-at-risk (VaR) reporting of counterparty risk as well as measurement of wrong-way risk and establishment of the concept of multilateral netting using central clearing of counterparty risk.

Suggested Citation

Mathur, Sumit and Skoglund, Jimmy, Counterparty Exposure Management in the Basel III Era (June 1, 2011). Available at SSRN: https://ssrn.com/abstract=2056804 or http://dx.doi.org/10.2139/ssrn.2056804

Sumit Mathur (Contact Author)

SAS Institute Inc. ( email )

100 SAS Campus Drive
Cary, NC 27513-2414
United States

Jimmy Skoglund

SAS Institute Inc. ( email )

100 SAS Campus Drive
Cary, NC 27513-2414
United States

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