The CVA Risk Capital Charge

The CVA risk capital charge comes up when a bank calculates the capital for changes in CVA and reflects it in the capital adequacy ratio. It also bears on a bank's application for SA-CVA (the standardized approach) approval and setting up monthly reporting.

What the CVA risk capital charge requires

CVA risk is the risk that CVA changes because of market moves such as changes in credit spreads. It does not include changes caused by the bank's own credit risk. CVA here is the difference between the fair value of a position without taking the counterparty's credit risk into account and the fair value with it taken into account¹. Accounting CVA is separate from this regulatory calculation.

The charge exists because of the financial crisis. In some cases during the crisis, mark-to-market losses on derivatives were larger than the losses from actual counterparty defaults. The causes included the deterioration of counterparties' credit quality. Basel II had a capital framework for counterparty default, but none for the mark-to-market risk of CVA. Basel III, published in 2010, added a capital charge for changes in CVA on top of the framework for default². The capital for default is the capital for counterparty credit risk (CCR), and the capital for changes in CVA is CVA risk capital.

Before the review, the framework of the Basel Committee on Banking Supervision (BCBS) had two methods. One was the advanced method, which measures with a VaR that uses the counterparty's credit spread. The other was the standardized method, which measures from the CCR EAD using a formula set by the BCBS. Problems raised before the review included that the framework did not capture changes in exposure driven by market factors, that it diverged from CVA hedging practice and from accounting CVA, and that it did not reflect the size or characteristics of financial institutions³.

The Group of Central Bank Governors and Heads of Supervision (GHOS) approved the finalization of Basel III on December 7, 2017. It included a review of the CVA risk framework⁴. The review organized the measurement methods into two approaches (BA-CVA and SA-CVA) and a simplified approach⁵. The Basel framework as a whole and the application dates for each category are covered in The Basel Framework and Derivatives.

Basis and covered transactions

In Japan, Chapter 8-2 "CVA risk" of the Financial Services Agency's capital adequacy notice under the Banking Act sets out the calculation⁶. A bank that calculates credit risk with the standardized approach adds the CVA risk equivalent amount divided by 8% to the total of its credit risk-weighted assets⁷.

CVA covered transactions are derivative transactions (the Notice's term for derivatives trading), repo-style transactions subject to mark-to-market valuation in the bank's financial accounting, and margin transactions, among others. Immaterial ones are excluded. Transactions with the following counterparties are also excluded: qualifying central counterparties, the direct clearing member in the case of a transaction of an indirect clearing participant that meets certain requirements, and funds settlement institutions and similar entities⁶. When the counterparty to an external CVA hedge is also a counterparty to a CVA covered transaction, the CVA risk equivalent amount for that counterparty is also calculated⁸.

Three calculation methods and how to choose

The calculation methods are two approaches and one simplified approach, matched to the size and characteristics of financial institutions, and the supervisory approval needed to use them differs⁵.

The columns of the table follow the 2018 overview by the Financial Services Agency and the Bank of Japan. The approval requirement and the range of banks that can use the simplified approach come from the Notice⁹¹⁰. A bank that uses SA-CVA still uses BA-CVA for netting sets for which SA-CVA is not appropriate¹¹. BA-CVA can be calculated even when accounting CVA is not calculated¹².

Figure description

There are two questions: whether there is a transaction to be included in the calculation (for example, a derivative with a counterparty other than a qualifying central counterparty, QCCP), and whether the bank has received approval for SA-CVA. If the answer to question 1 is "No", the result is that there is no transaction to include. If the answer to question 2 is "No", that is, the bank has no approval, the bank calculates with BA-CVA, and a domestic-standard bank that meets the conditions may also use the simplified approach. With approval, the bank calculates with SA-CVA, but uses BA-CVA for netting sets where SA-CVA is not appropriate.

Conditions and a calculation example for the simplified approach

In the framework of the Basel Committee on Banking Supervision (BCBS), the simplified approach is limited to banks whose notional amount of non-centrally cleared OTC derivatives is 100 billion euros or less. It sets the CVA capital requirement equal to the CCR capital requirement and applies to the whole portfolio. Even when a bank meets the condition, the supervisor can prevent that bank from using it¹³. Under the Notice, a domestic-standard bank can use it if the total notional amount of its derivative transactions with counterparties other than qualifying central counterparties and certain others stays at 10 trillion yen or less from the end of the most recent fiscal period to the calculation reference date. The CVA risk amount is then 12% of the credit risk-weighted assets of those derivative transactions. The approach applies to the whole CVA portfolio and does not reflect hedges¹⁰.

Under the Notice, whether the simplified approach can be used is checked with the following two questions.

Figure description

The total notional amount in the second question covers derivative transactions with counterparties other than qualifying central counterparties (CCPs) and certain others, and is the amount from the end of the most recent fiscal period to the calculation reference date. If the answer to either question is no, the simplified approach cannot be used, and the bank calculates with BA-CVA or SA-CVA.

Consider a hypothetical example in which Bank G is a domestic-standard bank, and the total notional amount of its derivative transactions with counterparties other than qualifying central counterparties and certain others was 8 trillion yen from the end of the most recent fiscal period to the calculation reference date. The answer to both questions is yes, so the bank meets the conditions for using the simplified approach. If the credit risk-weighted assets of its derivative transactions with counterparties other than qualifying central counterparties and certain others are 250 billion yen, the CVA risk amount is $250 \times 12\% = 30$ billion yen. Under this simplified approach, the effect of CVA hedges is not reflected in the CVA risk amount. If the total notional amount were 12 trillion yen, it would exceed 10 trillion yen, so the simplified approach could not be used, and the bank would calculate with BA-CVA or SA-CVA.

BA-CVA formulas and a worked example

Structure of the formulas

BA-CVA calculates a value $S_{c}$ for each counterparty and aggregates the values using a correlation between counterparties. There are two forms, depending on whether hedges are reflected.

The capital without hedges, $K_{\text{reduced}}$, is given by the following formula.

$$K_{\text{reduced}} = \sqrt{\left(\rho \sum_{c} S_{c}\right)^{2} + (1-\rho^{2}) \sum_{c} S_{c}^{2}}$$

$\rho$ is 0.5. The value $S_{c}$ for counterparty $c$ is obtained as follows over all of the counterparty's netting sets $NS$¹⁴.

$$S_{c} = \frac{1}{\alpha} \, RW_{c} \sum_{NS} M_{NS} \cdot EAD_{NS} \cdot DF_{NS}$$

$\alpha$ is 1.4 for SA-CCR and the expected exposure method, and 1 for the current exposure method. When the counterparty has specific characteristics under the expected exposure method, a more conservative value is used. A bank approved for the expected exposure method uses a different effective maturity for $M_{NS}$, and $DF_{NS}$ is 1.

The SA-CCR EAD is the sum of replacement cost and potential future exposure (PFE), multiplied by 1.4¹⁵. A bank using SA-CCR therefore divides the EAD, already multiplied by 1.4, by $\alpha = 1.4$ in the formula for $S_{c}$. How to obtain the EAD is covered in The Standardized Approach for Counterparty Credit Risk (SA-CCR).

$RW_{c}$ is set by the table in the Notice as follows¹⁶.

The form that reflects hedges (the full BA-CVA) takes a weighted average of the capital with hedges reflected, $K_{\text{hedged}}$, and $K_{\text{reduced}}$. The form that does not reflect hedges (the reduced BA-CVA) sets $\beta$ to 1 and does not reflect the effect of hedges. In both, the amount multiplied by the discount factor of 0.65 is the CVA risk equivalent amount¹⁷¹⁸.

$$K_{\text{full}} = \beta K_{\text{reduced}} + (1-\beta) K_{\text{hedged}}, \quad \beta = 0.25$$ $$K_{\text{hedged}} = \sqrt{\left(\rho \sum_{c} (S_{c}-SNH_{c}) - IH\right)^{2} + (1-\rho^{2}) \sum_{c} (S_{c}-SNH_{c})^{2} + \sum_{c} HMA_{c}}$$

$SNH_{c}$ is the effect of hedges that reference a single obligor of counterparty $c$, such as CDS. $IH$ is the effect of index hedges. $HMA_{c}$ is the part of the difference (basis) that remains for hedges that do not reference the counterparty directly. The effect of hedge $h$ is obtained in the following form¹⁹.

$$SNH_{c} = \sum_{h \in c} \gamma_{hc} \cdot RW_{h} \cdot M_{h}^{SN} \cdot B_{h}^{SN} \cdot DF_{h}^{SN}, \quad HMA_{c} = \sum_{h \in c} (1-\gamma_{hc}^{2}) \left(RW_{h} \cdot M_{h}^{SN} \cdot B_{h}^{SN} \cdot DF_{h}^{SN}\right)^{2}$$

$\gamma_{hc}$ is a correlation set by what the hedge references. It is 100% if the hedge references the counterparty directly, and 80% if it references an entity legally related to the counterparty. A hedge that references an entity in the same sector and region gets 50%. $B$ is the notional amount of the hedge, and $M$ is the effective maturity of the hedge.

Bank T's calculation example

Consider a hypothetical example in which Bank T trades with Company V, a financial institution (investment grade, its only counterparty), in a single netting set, with an SA-CCR EAD of 1.4 billion yen and an effective maturity of 3 years. Because Bank T uses SA-CCR, $\alpha$ is 1.4.

First, the discount factor is $DF = (1-e^{-0.15})/0.15 = 0.9286$. Next, the risk weight for investment-grade financials is 5.0%, so $S_{c} = (1/1.4) \times 0.05 \times 3 \times 1{,}400 \times 0.9286 = 139.3$ million yen. With one counterparty, $K_{\text{reduced}}$ equals $S_{c}$ at 139.3 million yen. Without hedges, the CVA risk equivalent amount is $0.65 \times 139.3 = 90.5$ million yen, and the addition to credit risk-weighted assets, obtained by dividing by 8%, is 1,132 million yen.

Next, compare two cases in which Bank T hedges the CVA on Company V with a CDS that has an effective maturity of 3 years and a notional amount of 1 billion yen. In one, the CDS references Company V directly ($\gamma$ is 100%). In the other, the CDS references a different company in the same sector and region as Company V ($\gamma$ is 50%). In both, the CDS reference is a financial with a risk weight of 5.0%.

In the directly referenced CDS case, the hedge effect $SNH_{c}$ equals $S_{c}$ at 139.3 million yen, and $K_{\text{hedged}}$ becomes zero. Even so, because $\beta = 0.25$, 25% of $K_{\text{reduced}}$ remains in $K_{\text{full}}$. For the CDS on the same sector and region, the effect falls to 69.6 million yen, and the basis amount $HMA_{c}$ of 14,552 (million yen squared) is added. With the numbers in this example, $K_{\text{hedged}}$ equals the unhedged 139.3 million yen, and capital does not fall. This is a result only of this example's combination of a $\gamma$ of 50% and the same notional amount, and it does not mean that a partial hedge never works. The economic effect of a hedge and the effect recognized in the capital calculation do not match in this way. A different notional amount or correlation would give a different result.

SA-CVA formulas and conditions for approval

Structure of the formulas

SA-CVA is an approach that uses CVA sensitivities. As in the FRTB standardized approach, it multiplies risk sensitivities by risk weights and aggregates them using correlations²⁰. The CVA risk equivalent amount is the sum of the delta risk part and the vega risk part. Delta risk is calculated for six risk classes: interest rate, foreign exchange, counterparty credit spread, reference-name credit spread, equity, and commodity. Vega risk is calculated for five of them, excluding counterparty credit spread²¹. Correlations between risk classes are not recognized, and the classes are simply added²⁰.

For each risk factor $k$, the CVA sensitivity $s_{k}^{CVA}$ and the sensitivity of the qualifying hedging instruments $s_{k}^{Hdg}$ are calculated, and the difference after multiplying by the risk weight $RW_{k}$ is the net weighted sensitivity $WS_{k}$²².

$$WS_{k} = RW_{k} \, s_{k}^{CVA} - RW_{k} \, s_{k}^{Hdg}$$

The capital for each bucket $b$, $K_{b}$, is obtained by aggregating $WS_{k}$ within the bucket using the correlation $\rho_{kl}$, and adding, as an allowance for hedges not working perfectly, the square of the weighted sensitivity of the hedges multiplied by $R = 0.01$. The capital for a risk class is aggregated using the correlation between buckets $\gamma_{bc}$, as follows²².

$$K = m_{CVA} \sqrt{\sum_{b} K_{b}^{2} + \sum_{b} \sum_{c \neq b} \gamma_{bc} \, S_{b} \, S_{c}}$$

$S_{b}$ is the sum of $WS_{k}$ within the bucket, limited to the range from $-K_{b}$ to $K_{b}$. The multiplier $m_{CVA}$ is 1 in the Notice. The Commissioner of the Financial Services Agency raises it when the Commissioner judges it necessary to address model risk in the CVA calculation²³. The Notice sets the tables of risk weights, correlations, and buckets for each risk class.

Conditions for approval

A bank that uses SA-CVA must first obtain the approval of the Commissioner of the Financial Services Agency, and keeps using it unless the approval is revoked⁹. The approval review looks at matters such as whether the exposure measurement model has been used in the bank's risk management for at least one year before approval²⁴. A bank with approval (an SA-CVA bank) calculates the CVA risk equivalent amount every month and reports it to the Commissioner²⁵.

The approval criteria include the following²⁶.

• The bank sets up a CVA desk staffed with traders who lead CVA risk management and execute hedge transactions. Documents showing the state of risk management are produced at least once a week.
• The bank has a unit that validates the exposure measurement model, independent of the trading units and the CVA desk.
• Internal audit reviews the whole CVA risk management process at least once a year.

CVA is measured as the expected value of the loss from counterparty default. Its components are the probability of default, estimated from observed market credit spreads and similar data; the loss given default (LGD) used in deriving that probability of default; and the future exposure from simulation. The SA-CVA bank's own default risk is not taken into account²⁷. Future exposure is measured with the model used to measure accounting CVA, and the recognition of netting is the same as for accounting CVA²⁸.

The effect of collateral is recognized only if legal requirements are met. The period during which collateral is not exchanged (the margin period of risk) has a floor of 4 business days for repo-style transactions and similar, and 9 business days for others, in each case plus the interval $N$ between collateral exchanges (1 for daily)²⁹.

CVA hedges and the other capital charges

An external transaction recognized as a qualifying hedge of CVA risk is subject to capital under the CVA risk framework and is not included in the measurement of market risk. This avoids holding capital twice³⁰. External hedges that do not qualify are subject to market risk³¹.

CVA can be hedged through internal transactions with other trading desks in the bank as well as through external transactions. An internal transaction is made up of positions at the CVA desk and the trading desk that fully offset each other. If an internal transaction carries risks that only the market risk framework captures, conditions apply before it can be recognized as a qualifying hedge. The risks concerned are curvature risk, default risk, and residual risk. The trading desk must have entered into a transaction with a third party that fully offsets its position with the CVA desk³¹³²³³.

The conditions for a qualifying hedge differ by approach. For BA-CVA, they are limited to single-name CDS, contingent CDS, and index CDS³². For SA-CVA, a transaction qualifies if it is used and managed for the purpose of reducing CVA risk and the hedged item and the hedging instrument are documented, and hedges in interest rates, foreign exchange, equity, commodities, and so on can also be reflected. However, hedge transactions that use securitization exposures or investments in funds that cannot be looked through do not qualify³³.

CVA risk capital shares inputs and frameworks with other capital charges. BA-CVA takes the EAD obtained with SA-CCR or another approach as its input. SA-CVA uses the same sensitivity-based framework as the standardized approach of FRTB and uses the model that measures accounting CVA to measure future exposure²⁰²⁸.

Effective dates and differences from the 2018 overview

In Japan, the amendment to the Notice (FSA Notice No. 22 of 2022, dated April 28, 2022) applies from March 31, 2023. The calculation of the capital adequacy ratio until the day one year after the application date (two years for domestic-standard banks that do not use internal models) follows the previous rules³⁴. As of October 2026, this transitional period has already ended (March 31, 2024 for the one-year period and March 31, 2025 for the two-year period). Applications for SA-CVA approval could be filed before the application date³⁵. The simplified approach does not apply to a bank that calculated the CVA risk equivalent amount under the previous provisions of the Notice before the application date³⁶.

The February 2018 overview by the Financial Services Agency and the Bank of Japan is a document that helps readers understand the BCBS final document³⁷. The final document was published in December 2017⁴. The overview and the Notice as updated on August 24, 2026 differ on the following points³⁸.

The formulas and the figures for BA-CVA and SA-CVA come from the Notice, except for the "February 2018 overview" column of the table. The descriptions of Basel III in 2010 and of the finalization on December 7, 2017 come from the overview and the press release.

Practical impact

The procedures a bank needs depend on the approach. BA-CVA requires no approval. SA-CVA requires the approval of the Commissioner of the Financial Services Agency, and an approved bank sets up the systems to calculate the CVA risk equivalent amount every month and report it³⁹. Hedge transactions are reflected in the calculation of the CVA risk equivalent amount only if they meet the eligibility conditions of each approach³²³³.

Notes

1. Financial Services Agency, "銀行法第十四条の二の規定に基づき、銀行がその保有する資産等に照らし自己資本の充実の状況が適当であるかどうかを判断するための基準" (Standards for determining whether a bank's capital adequacy is appropriate in light of the assets it holds, under Article 14-2 of the Banking Act, our translation; FSA Notice No. 19 of 2006, full text updated on August 24, 2026; below, "the Notice"), Article 1, item 77-2, "CVA risk" (page 22) (in Japanese). ↩

2. Financial Services Agency and Bank of Japan, "「信用評価調整（CVA）リスクの最低所要自己資本」の概要" (Overview of "Minimum capital requirements for credit valuation adjustment (CVA) risk", our translation) (February 2018; below, "the 2018 overview"), section 1, "これまでの経緯" (Background) (page 2). "Mark-to-market losses" and "mark-to-market risk" in the text translate the terms 時価損失 and 時価変動リスク in this document (in Japanese). ↩

3. The 2018 overview, section 2, "現行のCVAリスク規制" (The current CVA risk rules) (page 3) (in Japanese). ↩

4. Financial Services Agency, "プレス・リリース「中央銀行総裁・銀行監督当局長官はバーゼルⅢの最終化に合意」（仮訳）" (Japanese provisional translation of the press release of the Central bank Governors and Heads of Supervision on the finalization of Basel III; the English title is our translation) (December 7, 2017), page 1 (the approval date, and that the reforms include a review of the CVA risk framework) and page 2 (that the final rule document was published on the same day) (in Japanese). ↩ ↩²

5. The 2018 overview, section 3, "CVAリスクの見直しの概要" (Summary of the review of CVA risk) (page 4) (in Japanese). ↩ ↩²

6. The Notice, Article 270-2, paragraphs 1 and 2 (pages 393–394 of the full text). "Subject to mark-to-market valuation" is the term of paragraph 2, while the definition of CVA in Article 1, item 77-2, uses "fair value" (in Japanese). ↩ ↩²

7. The Notice, Article 48, paragraph 1, item 3 (page 136) (in Japanese). ↩

8. The Notice, Article 270-2-3 (pages 394–395) (in Japanese). ↩

9. The Notice, Article 270-4 (page 400) (in Japanese). ↩ ↩²

10. The Notice, Article 270-5, paragraph 1 (page 429). It applies to the whole portfolio and cannot reflect the hedging effect of CVA risk hedging instruments (paragraph 2 of the same Article) (in Japanese). ↩ ↩²

11. The Notice, Article 270-4-14, paragraph 1 (page 406). The requirements for splitting a netting set are in paragraph 2 of the same Article (in Japanese). ↩

12. The 2018 overview, section 6, "基礎的方式(BA-CVA) ～CVAヘッジを勘案しない場合(Reduced version)～" (Basic approach (BA-CVA), without CVA hedges (reduced version)) (page 9) (in Japanese). ↩

13. The 2018 overview, section 3, "CVAリスクの見直しの概要" (Summary of the review of CVA risk) (page 4), and section 7, "簡便法" (Simplified approach) (page 11) (in Japanese). ↩

14. The Notice, Article 270-3-3, paragraphs 1 and 2 (pages 396–397). The discount factor is the $DF_{NS}$ formula in paragraph 2 of the same Article. A bank approved for the expected exposure method uses the effective maturity under Article 158, paragraph 1, for $M_{NS}$ and 1 for $DF_{NS}$ (in Japanese). ↩

15. The Notice, Article 79-2, paragraph 1, "exposure amount = 1.4 × (RC + PFE)" (page 190) (in Japanese). ↩

16. The Notice, the table in Article 270-3-3, paragraph 3 (pages 397–398) (in Japanese). ↩

17. The Notice, Article 270-3-3, paragraph 1 (page 396). $\beta$ is 0.25, $\rho$ is 0.5, and the discount factor ($DS_{\text{BA-CVA}}$) is 0.65 (in Japanese). ↩

18. The Notice, Article 270-3 (page 395) and Article 270-3-4 (page 399). The reduced BA-CVA is the amount obtained by multiplying $K_{\text{full}}$, calculated with $\beta$ set to 1, by 0.65 (in Japanese). ↩

19. The Notice, Article 270-3-3, paragraphs 4, 5, and 7 (pages 398–399). The values of $\gamma_{hc}$ are in the table in paragraph 4 of the same Article. $IH$ for index hedges is in paragraphs 5 and 6 (adjustments such as multiplying the risk weight by 0.7). $DF_{h}^{SN}$ is $(1-e^{-0.05\,M_{h}^{SN}})/(0.05\,M_{h}^{SN})$ (in Japanese). ↩

20. The 2018 overview, section 5, "標準的方式(SA-CVA) ～計算の概要～" (Standardized approach (SA-CVA), outline of the calculation) (page 6) (in Japanese). ↩ ↩² ↩³

21. The Notice, Article 270-4-7, paragraphs 1 to 3 (pages 401–402) (in Japanese). ↩

22. The Notice, Article 270-4-8, paragraphs 3 to 6 (pages 402–403). $R$ is 0.01 (the hedging disallowance) in paragraph 5 of the same Article. The exact form of the within-bucket aggregation formula is in paragraph 5 of the same Article (in Japanese). ↩ ↩²

23. The Notice, Article 270-4-10 (page 404) (in Japanese). ↩

24. The Notice, Article 270-4-3 (page 400) (in Japanese). ↩

25. The Notice, Article 270-4-6 (page 401) (in Japanese). ↩

26. The Notice, Article 270-4-38, paragraph 2, item 3 (CVA desk, and documents at least once a week), item 6 (independence of the validation unit), and paragraph 5 (internal audit at least once a year) (pages 426–428) (in Japanese). ↩

27. The Notice, Articles 270-4-31 to 270-4-33 (pages 422–423) (in Japanese). ↩

28. The Notice, Article 270-4-34, paragraphs 1 to 5 (pages 423–424) (in Japanese). ↩ ↩²

29. The Notice, Article 270-4-35, paragraph 1 and paragraph 2, item 3 (pages 424–425) (in Japanese). ↩

30. The 2018 overview, section 4, "CVAヘッジの取り扱い" (Treatment of CVA hedges) (page 5) (in Japanese). ↩

31. The Notice, Article 11-13, paragraphs 1 to 4 (page 61) (in Japanese). ↩ ↩²

32. The Notice, Article 270-3-2 (pages 395–396) (in Japanese). ↩ ↩² ↩³

33. The Notice, Article 270-4-13, paragraphs 1 and 2 (page 405). The products excluded are those in the items of Article 271-2, paragraph 6, which the proviso of the same paragraph cites (page 435) (in Japanese). ↩ ↩² ↩³

34. The Notice (FSA Notice No. 22 of April 28, 2022), Supplementary Provisions Article 1 and Article 2, paragraphs 1 and 2 (pages 596–597) (in Japanese). ↩

35. The same Supplementary Provisions, Article 16 (page 605) (in Japanese). ↩

36. The same Supplementary Provisions, Article 17 (page 605) (in Japanese). ↩

37. The 2018 overview, page 1 (note on the cover) (in Japanese). ↩

38. The 2018 overview, section 3, "CVAリスクの見直しの概要" (Summary of the review of CVA risk) (page 4), section 5, "標準的方式(SA-CVA)" (The standardized approach, SA-CVA) (page 6), section 6, "基礎的方式(BA-CVA)" (The basic approach, BA-CVA) (page 9), and section 7, "簡便法" (The simplified approach) (page 11). The Notice: Article 270-5, paragraph 1 (page 429), Article 270-3-3, paragraphs 1 and 3 (pages 396–397), and Article 270-4-10, paragraph 1 (page 404) (in Japanese). ↩

39. The Notice, Article 270-4-3 (page 400; the review of whether the bank is expected to meet the approval criteria), and Articles 270-4-36 and 270-4-37 (page 425; setting up the systems for the monthly calculation and reporting) (in Japanese). ↩