Credit Risk Mitigation Techniques & Netting Agreements

The term of credit risk mitigation refers to positions for institutions to ensure collateral terms of reducing risk arising due to credit positions are taken care off. As a matter of fact the solvency regulation specifies the extent to which collateralizations are recognized.

Also, in addition to financial collateral and guarantees of recognized protection providers, all institutions recognize the assignment of claims or physical collateral which may very well count as a risk mitigants, when institutions use IRBA or an IRBA institution. Where advanced IRBA’s are used, the range of eligible collateral is even unlimited provided an institution provides a reliable estimate to the value of the assets. For credit risk mitigation techniques to be recognized we need to calculate the minimum capital requirements. But institutions must also comply to certain minimum qualitative requirements, which are specified explicitly in solvency regulation.

On condition that an eligible netting agreement is concluded bilaterally with reference to a respective contractual partner, derivative & non derivative transactions can be netted against one another according to solvency regulation. On balance sheet, netting of mutual money claims & debts arising out of it is also permitted as per the regulation. In case of cross product netting effect, institutions take into account netting effect in case of risk exposures from different product category.

Thus it becomes permissible to net derivative counterparty in case of risk exposures against non derivative transactions with access to repurchase, lending or comparable agreements. But for cross product netting agreement the most sensitive of all methods which is called internal model method is absolutely mandatory.