Introduction

57.Banks may use a number of techniques to mitigate the credit risks to which they are exposed. For example, exposures may be collateralised by first priority claims, in whole or in part with cash or securities, a loan exposure may be guaranteed by a third party, or a bank may buy a credit derivative to offset various forms of credit risk. Additionally, banks may agree to net loans owed to them against deposits from the same counterparty.

58.In this Standard, “counterparty” is used to denote a party to whom a bank has an on or off-balance sheet credit exposure. That exposure may, for example, take the form of a loan of cash or securities (where the counterparty would traditionally be called the borrower), of securities posted as collateral, of a commitment or of exposure under an OTC derivatives contract

General Requirements for legal certainty

59.The Central Bank recognizes certain credit risk mitigation techniques for regulatory capital purposes, provided that all documentation used in collateralised transactions and for documenting on-balance sheet netting, guarantees and credit derivatives are binding on all parties and legally enforceable in all relevant jurisdictions, and that banks have conducted sufficient legal review to verify this and have a well-founded legal basis to reach this conclusion, and undertake such further review as necessary to ensure continuing enforceability.

60.Where a bank has a single exposure covered either by more than one type of credit risk mitigation, or by differing maturities of protection provided by the same credit protection provider, the bank shall:

1. (i)Subdivide the exposure into parts covered by each type or maturity of credit risk mitigation tool; and
2. (ii)Calculate the risk-weighted assets for each part obtained in point (i) above separately in accordance with the risk weights applicable to each exposure category as described in the relevant section.

61.The comprehensive approach for the treatment of collateral (described further below from paragraph 85) shall also be applied to calculate the counterparty risk charges for OTC derivatives and repo-style transactions booked in the trading book.

62.No transaction in which CRM techniques are used shall receive a higher capital requirement than an otherwise identical transaction where such techniques are not used.

63.The effects of CRM shall not be double counted. Therefore, no additional supervisory recognition of CRM for regulatory capital purposes shall be granted on claims for which an issue-specific rating is used that already reflects that CRM. Principal-only ratings shall also not be allowed within the framework of CRM to claims for which an external credit assessment can be conducted.

64.Considering that, while the use of CRM techniques reduces or transfers credit risk, it simultaneously may increase other risks (residual risks), and that residual risks include legal, operational, liquidity and market risks, banks shall employ robust procedures and processes to control these risks, including strategy, consideration of the underlying credit, valuation, policies and procedures, systems, control of roll-off risks, and management of concentration risk arising from the bank’s use of CRM techniques and its interaction with the bank’s overall credit risk profile. Where these risks are not adequately controlled, the Central Bank may impose additional capital charges or take other supervisory actions under Pillar 2.

65.The banks shall also observe the Central Bank’s Pillar 3 requirements to obtain capital relief in respect of any CRM techniques.