Gary W. van Vuuren, Ph.D, Fitch Ratings, 131 Regents Court, Sopwith Way, Kingston upon Thames, London, KT2 5AQ, United Kingdom
The Internal Ratings-based Approach of the New Basel Accord allows banks to employ the double default effect of guaranteed exposures. In effect, this approach requires a bank that uses a credit guarantee to hedge the credit risk associated with a loan will incur a loss only if both the obligor and the guarantor default at the same time. In general such joint default events are much less likely than individual default events, even when the underlying asset values of the two counterparties are relatively highly correlated. It has been shown that the capital charge for an individual exposure may be derived (using the Asymptotic-Single-Risk-Factor framework) by calculating its conditional expected loss function, given an adverse draw of a single systematic risk factor. The "credit crisis" arguably still unfolding in various global locations has witnessed more and more central governments stepping in to support failing banks. Bank guarantees have been transformed into government guarantees, with associated diminished probabilities of default. The effect of these on Basel II's counterparty credit risk charges (specifically with reference to Basel II's approach to double default) will be examined