35.Under the standardised approach, off-balance sheet items are converted into credit exposure equivalents with Credit Conversion Factors (CCFs). CCFs approximate the potential amount of the off-balance sheet facility that would have been drawn down by the client by the time of its default. The credit equivalent amount is treated in a manner similar to an on-balance sheet instrument and is assigned the risk weight appropriate to the counterparty. The categories of off-balance sheet and its appropriate CCFs are outlined in the standard.

    Calculating credit equivalent amounts for off-balance sheet item:

    (Principal amount – provision amount) * CCF = Credit equivalent amount.

Bank guarantees

36.There are two types of bank guarantees viz. financial guarantees (direct credit substitutes); and performance guarantees (transaction-related contingent items).

37.Financial guarantees essentially carry the same credit risk as a direct extension of credit i.e. the risk of loss is directly linked to the creditworthiness of the counterparty against whom a potential claim is acquired, and therefore attracts a CCF of 100%.

38.Performance guarantees are essentially transaction-related contingencies that involve an irrevocable undertaking to pay a third party in the event the counterparty fails to fulfil or perform a contractual non-financial obligation. In such transactions, the risk of loss depends on the event which need not necessarily be related to the creditworthiness of the counterparty involved. Performance guarantees attract a CCF of 50%.

Commitments

39.The credit conversion factor applied to a commitment is dependent on its maturity. Banks should use original maturity to report these instruments.

40.Longer maturity commitments are considered to be of higher risk because there is a longer period between credit reviews and less opportunity to withdraw the commitment if the credit quality of the customer deteriorates. Commitments with an original maturity up to one year and commitments with an original maturity over one year will receive a CCF of 20% and 50%, respectively.

41.However, any commitments that are unconditionally cancellable at any time by the bank without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower’s creditworthiness, will receive a 0% CCF. This requires that banks conduct formal reviews of the facilities regularly and this provides the opportunity to take note of any perceived deterioration in credit quality and thereby cancellability by the bank.

42.For exposures that give rise to counterparty credit risk, the exposure amount to be used in the determination of RWA is to be calculated according to the standardised approach for Counterparty Credit Risk (SA-CCR).