Capital Briefs: Credit Derivatives Added to Market Risk Rules

The Federal Reserve Board has expanded its market risk rules to cover credit derivatives.

Richard Spillenkothen, the Fed's director of banking supervision and regulation, wrote in a supervisory letter that banks subject to the market risk rules must use internal models to set capital requirements for credit derivatives.

The June 13 letter, released last week, also requires banks to hold capital against the risk that a counterparty will default on a deal.

To calculate this charge, the bank should multiply the market value of the credit derivative by a special add-on factor, the Fed said. For investment-grade credit derivatives, the add-on factor is 6% for contracts of less than one year, 8% for those between one and five years, and 10% for all other deals.

For other credit derivatives, the add-on factor is 10%, 12%, and 15% respectively for contracts of less than a year, of one-to-five years, and of more than five years.

Finally, the letter makes it easier for banks to reduce capital requirements by holding offsetting credit derivatives. Previously, banks had to hold exactly matched products. Now they may lower their capital charge even if the credit derivatives have different maturities.

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