Module: | MODULE B: RISK MANAGEMENT
Q290: Consider the following statements regarding the mechanics of Credit Conversion Factors (CCF) for off-balance sheet exposures:
1. A Credit Conversion Factor (CCF) is a regulatory percentage, applied to an off-balance sheet exposure to estimate its on-balance sheet credit equivalent amount.
2. Financial bank guarantees typically attract a 100% CCF, because they carry the exact same direct credit risk as a funded term loan.
3. Once the Credit Equivalent Amount (CEA) is calculated using the CCF, it is completely exempted from any further risk-weighted capital charge.
Which of the statements given above is/are correct?
2. Financial bank guarantees typically attract a 100% CCF, because they carry the exact same direct credit risk as a funded term loan.
3. Once the Credit Equivalent Amount (CEA) is calculated using the CCF, it is completely exempted from any further risk-weighted capital charge.
Which of the statements given above is/are correct?
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: The core mechanism for capitalizing off-balance sheet items under Basel/RBI norms is to convert the notional principal amount into an on-balance sheet equivalent.
This is done by multiplying the notional amount by a regulatory Credit Conversion Factor (CCF) to arrive at the Credit Equivalent Amount (CEA). Statement 2 is correct: A direct financial substitute, such as a financial bank guarantee, attracts a 100% CCF.
Regulators view guaranteeing someone else's financial debt as carrying the exact same default risk as lending them the money directly.
Statement 3 is incorrect: Calculating the CEA is only step one.
Once the CEA is determined, it is NOT exempt from capital charges.
Instead, the bank must multiply the CEA by the applicable Risk Weight assigned to that specific counterparty (e.g., 20%, 50%, 100%) to determine the final Risk-Weighted Asset (RWA) against which capital is held.
This is done by multiplying the notional amount by a regulatory Credit Conversion Factor (CCF) to arrive at the Credit Equivalent Amount (CEA). Statement 2 is correct: A direct financial substitute, such as a financial bank guarantee, attracts a 100% CCF.
Regulators view guaranteeing someone else's financial debt as carrying the exact same default risk as lending them the money directly.
Statement 3 is incorrect: Calculating the CEA is only step one.
Once the CEA is determined, it is NOT exempt from capital charges.
Instead, the bank must multiply the CEA by the applicable Risk Weight assigned to that specific counterparty (e.g., 20%, 50%, 100%) to determine the final Risk-Weighted Asset (RWA) against which capital is held.