Playing catch-up

Counterparty credit risk (CCR) management frameworks of leading banks have failed to keep pace with evolving regulatory requirements and enhanced scrutiny.

Amid the banking sector's quest to adapt to technological advances, several key links in the risk management framework remain vulnerable.

In this context, the European Central Bank (ECB) had conducted a targeted review of CCR processes of 23 financial institutions that were active in securities financing transactions (SFTs) and derivatives with non-banking counterparties (commodity trades, energy utilities, etc.).

It called out 43 sound practices across four focus areas: i) CCR governance ii) risk control, management and measurement, iii) stress testing and wrong-way risk (WWR), and iv) watchlist and default management. See Appendix 1 for details.

Following the review, the ECB highlighted the key areas to improve upon.

These included enhanced customer due diligence, better management of complex CCR exposures, stress test framework covering tail events (WWR, high leverage, maturity mismatch, crowded trades' non-linearity, and so on), and risk mitigation with early warning indicators.