Counterparty Credit Risk (CCR) is the risk that the other party in a financial transaction will default before the final settlement of the transaction's cash flows. Unlike traditional credit risk, CCR arises from derivative contracts, securities financing, and trading activities—not just loans.
📘 Key Definition
CCR is the risk that a counterparty to an over-the-counter (OTC) derivative or similar financial contract will fail to fulfill their obligations, potentially leaving the bank with a financial loss.
🏦 Where Does CCR Arise?
CCR is mainly found in:
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Derivatives (e.g., interest rate swaps, FX forwards)
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Securities lending and borrowing
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Repurchase agreements (repos)
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Margin lending and clearing activities
🧮 Example Scenario
Imagine Bank A enters into a 5-year interest rate swap with Bank B. Three years in, Bank B defaults. If the swap has a positive value to Bank A at that time, Bank A may lose money it expected to receive.
🔍 How CCR Differs from Traditional Credit Risk
| Feature | Traditional Credit Risk | Counterparty Credit Risk |
|---|---|---|
| Applies to | Loans | Derivatives, securities financing |
| Exposure is known? | Fixed (loan amount) | Fluctuates with market |
| Two-way risk? | No | Yes – both sides at risk |
| Settlement risk? | No | Yes – risk before and during settlement |
📉 Key Components of CCR
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Exposure at Default (EAD)
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The amount the bank expects to lose if the counterparty defaults.
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Probability of Default (PD)
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Likelihood the counterparty will default.
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Loss Given Default (LGD)
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How much of the exposure is lost after recoveries.
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💡 CCR = EAD × PD × LGD
🛠 Risk Mitigation Techniques
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Netting: Offsetting positions to reduce total exposure
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Collateral: Margin requirements help reduce potential loss
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Central Clearing: Using clearing houses (CCPs) to manage risk
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Credit Valuation Adjustment (CVA): Adjusting the price of a contract to reflect CCR
📊 Regulatory Framework
CCR is heavily regulated under:
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Basel II & III: Introduced capital requirements for CCR
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SA-CCR: Standardized Approach for measuring CCR exposure (replacing older methods)
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CVA Capital Charge: Extra capital buffer to account for market valuation of CCR
🔐 Why CCR Matters
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Large trading banks face billions in exposure through derivatives
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Mismanaging CCR was a key issue during the 2008 financial crisis
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Effective CCR management is crucial for systemic stability
✅ Summary Table
| Aspect | Description |
|---|---|
| What is it? | Risk of loss from counterparty default |
| Applies to | Derivatives, securities financing |
| Measured by | EAD, PD, LGD, CVA |
| Managed using | Collateral, netting, clearing |
| Regulated under | Basel II/III, SA-CCR, CVA framework |