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Counterparty Credit Risk Management – Proposed Framework for Counterparty Credit Risk Management for a MEFMI Central Bank

  • June 7, 2016
  • Posted by: admin
  • Category: Financial Sector Management
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By Violet Chatsika
March 2011
Credit risk has drawn much attention in the financial world due to the recent credit turmoil. Central banks have restricted the class of counterparties they deal with and have adjusted limits allocated to the counterparties in a bit (bid) to control counterparty credit default in their foreign reserves management operations. For instance some MEFMI central banks are now trading with AAA rated institutions only. However this change of strategy may appear to have been done in an unsystematic manner without considering all the fundamentals of counterparty credit risk issues at hand. A better approach for controlling counterparty credit risk is to be able to (be to) have a full understanding of all the aspect of credit risk mitigating factors. and hedging possibilities. It is therefore important that a more thoughtful, relevant and detailed counterparty credit risk framework be developed through which foreign reserves could be effectively and efficiently managed with the ultimate objective of preserving capital and maximizing return in mind.
This paper therefore presents a new approach to (framework for ) counterparty credit risk management for a MEFMI central bank. The framework is developed in the light of the recent global credit turmoil and allows (where) the central bank (has) to scrutinize a counterparty more than ever before. The framework is based on pricing counterpary credit risk using the Credit Value Adjustment (CVA) theory. (which is the price of counterparty credit risk). The theory models credit risk exposure and discusses other operational risk management factors like IT systems, legal, regulatory and staff management as a counterparty credit risk management tool. The paper discusses the current strategies adopted in the region in managing counterparty credit risk and their limitations. Finally an overview of operations risk management that enhances counterparty credit risk management will be discussed.