Capital and Funding
14 Pages Posted: 26 Apr 2015 Last revised: 19 Nov 2015
Date Written: April 24, 2015
Banking operations are being rewired around a pair of KVA/FVA metrics which quantify market incompleteness, i.e. the impossibility of perfect replication. The FVA is the cost of funding of debt liabilities while the KVA is the risk adjustment for equity liabilities, also called cost of capital. The two metrics are intertwined with each other, since equity capital is itself a source of funding, fungible with debt financing.
In this paper, we define the KVA and FVA metrics in terms of projections for Economic Capital and costs of funding. If implemented within the proper accounting framework, KVA/FVA mark-to-market leads to reporting rules for earnings which are both informative and useful to devise a sustainable strategy for dividend payments.
Keywords: KVA, FVA, OTC derivatives, CVA, counterparty credit risk
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation