Counterparty Credit Risk and Other Risk-Coverage Measures

Akhtar Siddique

This article was first published as a chapter in Basel III and Beyond on July 27, 2011, by Risk Books.

5.1 Introduction

This chapter covers the revisions to the counterparty credit risk (CCR) capital rules in the Basel III framework. Counterparty credit risk is the risk that counterparties will fail to meet their obligations. It most commonly arises in over-the-counter (OTC) derivatives transactions that have promised cashflows in the future and whose payment depends on the creditworthiness of the counterparty. Canabarro and Duffie (2003) provide the following definition: “counterparty risk is the risk that a party to an OTC derivatives contract may fail to perform on its contractual obligations, causing losses to the other party.”

Such a definition contains all the key features of counterparty credit risk and helps to highlight the difference with “traditional” credit risk. On the one hand, the fact that, for both risks, the cause of economic loss is the obligor’s default makes them very similar. On the other hand, counterparty credit risk has two specific features, represented by the uncertainty of the exposure and the bilateral nature of the risk; in other words, in a