Perverse capital

Many banks adjust the value of trades to reflect the possibility of their own default, with the counter-intuitive effect that a rise in their credit spread appears as a profit. Basel refuses to recognise this in bank capital rules, but there is a split on the issue in the industry – and among regulators themselves. Laurie Carver introduces this month’s technical articles

The post-Lehman risk management landscape is different in many ways, but perhaps the most noticeable change is a greater sensitivity to counterparty credit risk. The Basel III capital requirements include a controversial charge for credit value adjustment (CVA) – the market value of changes in counterparty exposure, which regulators claim accounted for roughly two-thirds of banks’ losses during the financial crisis.

The design of the charge has evolved gradually. Flaws in the original equivalent