RBI Proposes New Credit Valuation Adjustment Framework for Commercial Banks from April 2027
The Reserve Bank of India (RBI) has proposed a new Credit Valuation Adjustment (CVA) Framework for commercial banks, aimed at strengthening the way banks calculate and hold capital against risks arising from changes in the credit quality of their derivative counterparties. The framework has been issued in draft form as the “Reserve Bank of India (Commercial Banks – Credit Valuation Adjustment Framework) Directions, 2026”. If implemented, the Directions will come into effect from April 1, 2027.
The proposed framework is particularly relevant for banks that undertake derivative transactions because the value of such transactions can change not only due to movements in market prices but also because of changes in the creditworthiness of the counterparty. RBI’s proposed rules seek to ensure that banks maintain adequate capital for this CVA risk, thereby strengthening the overall capital framework for derivative exposures.
What is Credit Valuation Adjustment (CVA)?
CVA is an adjustment made to the value of a derivative transaction to reflect the possibility that the counterparty may default. In simple terms, when a bank enters into a derivative contract with another party, the bank may expect to receive money in the future. However, there is always a possibility that the counterparty’s financial position may deteriorate or that it may default. This credit risk affects the value of the derivative.
Under the draft framework, CVA is calculated at the counterparty level and represents an adjustment to the default-risk-free value of a derivative or Security Financing Transaction because of the potential default of the counterparty. RBI also clarifies that regulatory CVA may differ from accounting CVA because regulatory CVA does not include the effect of the bank’s own default and is subject to regulatory requirements.
RBI defines CVA risk as the risk of losses arising from changes in CVA values due to changes in the counterparty’s credit spreads as well as market factors that affect the prices of derivatives and SFTs. Therefore, even when there is no actual default, a deterioration in the perceived credit quality of a counterparty can result in losses for the bank.
Which banks will come under the proposed framework?
The proposed Directions will apply to commercial banks. For the purpose of the framework, commercial banks include banking companies, corresponding new banks and the State Bank of India, while Small Finance Banks, Payments Banks and Local Area Banks are excluded from this definition.
The new framework will cover specified derivative transactions. “Covered Transactions” broadly include derivatives, except derivatives transacted directly with a Qualified Central Counterparty (QCCP) and certain transactions already covered by specified exemptions under the RBI’s capital adequacy framework.
Banks will have to calculate CVA capital requirements on a standalone basis for covered transactions in both the banking book and trading book. The calculation will cover the bank’s entire portfolio of covered transactions and eligible CVA hedges. However, trades relating to Securities Financing Transactions (SFTs) will be excluded from the calculation of the CVA capital charge.
BA-CVA will be the main approach
Under the proposed framework, banks will generally have to use the Basic Approach for Credit Valuation Adjustment, or BA-CVA, for calculating their CVA capital charge. RBI has, however, proposed an alternate treatment for banks meeting a specified threshold.
The framework gives banks a choice between two versions of BA-CVA: the Reduced BA-CVA and the Full BA-CVA. The reduced version is intended to simplify implementation for banks that do not hedge their CVA risk, while the full version is designed for banks that actively hedge counterparty credit spread risk. Importantly, even a bank using the full BA-CVA will have to calculate the reduced BA-CVA as part of the overall calculation.
Alternate treatment available for smaller derivative portfolios
One of the important provisions of the draft is the alternate treatment for banks with relatively smaller non-centrally cleared derivative portfolios.
A bank whose aggregate notional amount of non-centrally cleared derivatives is ₹10 lakh crore or less may choose not to calculate its CVA capital requirement using BA-CVA. Instead, it may adopt the alternate treatment. However, this is not an unconditional right. RBI’s supervisory authority can disallow the option if it believes that CVA risk arising from the bank’s derivative positions materially contributes to the bank’s overall risk.
Under this alternate treatment, the bank’s CVA capital requirement will be equal to 100% of its capital requirement for Counterparty Credit Risk (CCR). Banks using this option will also not be permitted to recognise CVA hedges, and the treatment will have to be applied to the bank’s entire portfolio of covered transactions.
This provision is significant because it provides a comparatively simpler route for eligible banks rather than requiring them to undertake the detailed BA-CVA calculations.
Reduced BA-CVA will not recognise hedges
Under the Reduced BA-CVA, CVA hedges are not recognised while calculating the capital requirement. RBI has proposed a discount scalar of 0.65 for the calculation. The capital requirement is calculated by applying this discount scalar to the calculated reduced CVA risk measure.
The calculation takes into account the CVA capital requirement of individual counterparties and then aggregates the risks while recognising that the credit spreads of different counterparties do not normally move together perfectly. RBI has prescribed a 50% supervisory correlation parameter, with the square of the correlation parameter being 25%. The framework therefore separates the risk into systematic and idiosyncratic components rather than simply adding the CVA risk of every counterparty.
The stand-alone CVA capital for each counterparty is based on factors including the counterparty risk weight, effective maturity, Exposure at Default (EAD) and supervisory discount factor. The discount factor uses a 5% discount rate, while the framework specifies an alpha multiplier of 1.4.
Risk weights will depend on sector and credit quality
The proposed framework introduces supervisory risk weights based on both the sector of the counterparty and its credit quality.
For example, for investment-grade counterparties, the proposed risk weight is 0.5% for sovereigns, 1% for local governments and certain government-backed entities, 5% for financial institutions, 3% for basic materials, energy, industrials, agriculture and manufacturing, 3% for consumer goods and services, 2% for technology and telecommunications, 1.5% for healthcare, utilities and professional and technical activities, and 5% for other sectors.
For high-yield and non-rated counterparties, the corresponding risk weights are significantly higher. They range from 2% for sovereigns to 12% for financials and other sectors.
RBI has also specified how credit quality is to be determined. Long-term ratings of BBB-/Baa3 and above are treated as investment grade, while ratings below these levels are treated as high yield. Where a counterparty has more than one rating, the worst rating will be used. If there is no external rating, the risk weight for a not-rated (NR) counterparty will apply.
Effective maturity will play an important role
The proposed calculation also gives importance to the effective maturity of transactions. Generally, the effective maturity of a netting set will have a minimum floor of one year, subject to specified exemptions.
Where transactions are covered by a legally enforceable netting agreement, the effective maturity of the netting set will be calculated as a weighted average maturity, with the notional amount of each transaction used for weighting. The framework also provides a specific exemption from the one-year floor for certain fully or nearly fully collateralised OTC derivatives having an original maturity of less than one year, provided daily re-margining and other prescribed conditions are met.
This means banks will need appropriate systems to accurately capture transaction maturity, netting arrangements, collateralisation and EAD while calculating CVA capital requirements.
Full BA-CVA will recognise eligible hedges
The Full BA-CVA is designed for banks that actively manage their CVA risk through hedging. Unlike the reduced approach, the full approach recognises the impact of eligible counterparty credit spread hedges.
The draft says that eligible CVA hedges can include single-name Credit Default Swaps (CDS), single-name contingent CDS and index CDS. However, RBI notes that banks are currently not permitted to engage in single-name contingent CDS, and therefore the effect of such instruments will not be recognised under the proposed framework.
For a single-name CDS to qualify, it must either directly reference the counterparty, reference an entity legally related to the counterparty, such as a parent or subsidiary, or reference an entity belonging to the same sector and region as the counterparty.
RBI puts a limit on the benefit of hedging
Although the full BA-CVA recognises eligible hedges, RBI has proposed a mechanism to prevent hedging from completely eliminating the capital requirement for CVA risk.
The full CVA capital requirement will be calculated using the reduced CVA measure and a hedged component. The framework specifies a supervisory parameter β of 0.25, which acts as a floor and limits the extent to which hedging can reduce the CVA capital requirement. The discount scalar for the full BA-CVA is also 0.65.
In simple terms, the proposed approach allows banks to receive capital benefit for genuine CVA hedges, but it does not allow the hedge to completely remove the regulatory capital requirement.
Different recognition for direct and indirect hedges
The framework also provides different levels of recognition depending on how closely the hedge is related to the counterparty.
If a single-name hedge directly references the counterparty, the prescribed correlation is 100%. If the hedge has a legal relationship with the counterparty, the correlation is 80%. If the hedge references an entity from the same sector and region as the counterparty, the correlation is 50%.
This approach reflects the fact that a hedge directly linked to the counterparty is expected to provide a stronger offset against changes in that counterparty’s credit spread than a hedge linked only indirectly to the counterparty.
For index hedges, RBI proposes a diversification adjustment. Where all constituents of an index belong to the same sector and have the same credit quality, the applicable risk weight will be multiplied by 0.7. For indices covering multiple sectors or different credit-quality categories, a name-weighted average risk weight will first be calculated and then multiplied by 0.7.
Special treatment proposed for external and internal CVA hedges
The draft also explains how banks should treat CVA hedges for capital purposes. Banks may use external CVA hedges, where the hedge is with an external counterparty, or internal CVA hedges, involving one of the bank’s own trading desks.
For external hedges, all covered external CVA hedges will be included in the CVA calculation of the counterparty providing the hedge. Eligible external CVA hedges will be excluded from the market risk capital requirement, while ineligible external CVA hedges will be treated as trading-book instruments and will attract market-risk capital requirements.
For internal hedges, if the hedge is ineligible, the two offsetting positions will remain in the trading book and cancel each other. If the hedge is eligible, the CVA desk’s position will form part of the CVA portfolio and will be capitalised for CVA risk, while the corresponding trading desk position will remain in the trading book and be capitalised for market risk.
CVA risk will also affect risk-weighted assets
The proposed framework does not stop at calculating a CVA capital charge. RBI has specified that the CVA risk-weighted assets (RWA) will be calculated by multiplying the applicable CVA capital charge by 12.5. This applies to the alternate treatment as well as the reduced and full BA-CVA approaches.
Therefore, the CVA framework will directly feed into a bank’s regulatory capital and RWA calculations. Banks with significant derivative portfolios may consequently need to assess the potential impact of the framework on their capital planning and risk-management systems.
RBI gives an example of the reduced BA-CVA calculation
The draft contains detailed illustrative examples in Annex 1 to help banks understand the proposed calculations. In the first example, RBI considers two investment-grade counterparties. The first is a bank with a 5% risk weight, three-year effective maturity and ₹1,000 crore EAD, while the second is a corporate-industrial counterparty with a 3% risk weight, two-year maturity and ₹600 crore EAD.
Using the prescribed calculations, the stand-alone CVA capital requirements for the two counterparties are ₹99.49 crore and ₹24.47 crore, respectively. The resulting reduced CVA risk measure, or K reduced, is ₹108.24 crore.
After applying the prescribed discount scalar of 0.65, the example results in a reduced BA-CVA capital requirement of ₹70.35 crore.
The example is important because it demonstrates how the framework moves from individual counterparty exposure to a portfolio-level CVA capital requirement rather than simply adding individual risks.
Full BA-CVA example shows benefit from hedging
The second example in Annex 1 demonstrates the full BA-CVA approach. It uses the same two counterparties but introduces single-name hedges. The hedge notional is ₹400 crore for Counterparty 1 and ₹200 crore for Counterparty 2, with hedge maturities of three years and two years respectively.
The example illustrates how eligible hedges reduce the calculated CVA risk while the framework’s supervisory parameters prevent the capital requirement from being reduced without limit. The example therefore demonstrates the practical difference between the reduced approach, where hedges are ignored, and the full approach, where eligible credit-spread hedges receive regulatory recognition.
Banks will have to make Pillar 3 disclosures
The proposed framework also introduces specific Pillar 3 disclosure requirements for CVA risk. Banks will have to provide qualitative information about their CVA risk management framework and quantitative information through prescribed templates.
The CVAA table will provide qualitative information about the bank’s CVA risk-management objectives and policies. It will be mandatory for banks subject to CVA capital requirements, including eligible banks that choose the alternate treatment. The disclosure will be annual and will explain how the bank identifies, measures, monitors and controls CVA risk, including its CVA hedging policies and processes for monitoring the effectiveness of those hedges.
The CVA1 template will apply to banks using the reduced BA-CVA. It will provide components used for calculating CVA RWA and will be submitted semiannually. Banks will also have to describe the types of hedges they use even though such hedges are not recognised under the reduced approach.
The CVA2 template will apply to banks using the full BA-CVA and will also be submitted semiannually. It will report K reduced, K hedged and the total CVA RWA.
Existing capital adequacy provision to be repealed
Once the new Directions come into effect on April 1, 2027, paragraph 85(3) of the RBI (Commercial Banks – Prudential Norms on Capital Adequacy) Directions, 2025 will stand repealed.
What the proposed framework means for banks
Overall, the draft represents a more structured approach to the capital treatment of CVA risk arising from derivative transactions. Instead of treating counterparty credit risk alone as the key consideration, the framework requires banks to consider how changes in counterparty credit spreads can affect the value of their derivative portfolios.
For banks with smaller non-centrally cleared derivative portfolios, the alternate treatment provides a simpler option by linking CVA capital directly to the CCR capital requirement, although CVA hedges cannot be recognised under this route. Larger or more sophisticated banks can use the BA-CVA framework, with the reduced version providing a simpler calculation without hedge recognition and the full version providing capital recognition for eligible CVA hedges.
The proposal also places greater importance on the quality of a counterparty, its sector, exposure size, maturity and the nature of hedging instruments. The use of specific risk weights, correlation parameters, discount factors and a limit on the benefit from hedging is intended to make the CVA capital calculation more risk-sensitive.
The key date for banks is April 1, 2027, when the proposed Directions are scheduled to come into effect. The draft therefore gives banks time to assess their derivative portfolios, CVA measurement systems, hedge arrangements, capital impact and Pillar 3 reporting requirements before implementation.
