Royal Bank of Canada’s credit valuation adjustment (CVA) charges have increased by more than a fifth in the six months under the updated Basel III regime, inflating at a far brisker rate than at its peers.

The dealer’s CVA risk-weighted assets rose 22.1% to C$15.7 billion ($11.5 billion) at the end of April, up from C$12.9 billion at end-October, on the eve of Canada’s adoption of revised RWA formulas under the Fundamental Review of the Trading Book (FRTB).

It was an outsized increase compared with the country’s other dealers, who likewise had to retire internal modelling of CVA requirements, which FRTB has disallowed. Bank of Montreal’s CVA RWAs rose 2.7% since the package’s implementation, while Canadian Imperial Bank of Commerce (CIBC), TD Bank and Scotiabank reaped compressions of 35%, 33.1% and 1.8%, respectively.

Part of the increase likely stemmed from the integration of HSBC Canada’s balance sheet, the acquisition of which was completed during the quarter.

Under FRTB, banks can seek regulatory permission to use the revised standardised approach to CVA risk-weighting, the most comprehensive approach set out by the framework. Dealers that lack such approval, such as RBC, need to fall back on the coarser-cut basic approach to CVA (BA-CVA), which recognises hedging only on the credit spread component of the charge, and to a capped extent.

Baking in hedges, RBC’s CVA RWAs would have been C$14.7 billion as of end-April, 21.3% or $4 billion lower than the unhedged figure. However, because of the BA-CVA’s cap on how much of that benefit can filter through to actual RWAs, the ultimate compression was limited to 10.4%, or $3 billion.

In the previous quarter, covering the three months to end-January, hedged RWAs were 23.3% or $4.1 billion lower before the cap, and 11.4% or $3.1 billion on an ultimate basis.

What is it?

The final batch of Basel III reforms revises parameters for the regulator-set standardised approaches, constrains internal model usage for credit risk and market risk, and removes banks’ use of internal models for CVA and operational risk. The market risk components are part of the Fundamental Review of the Trading Book.

For CVA, in order to use the revised standardised approach, a bank must meet certain requirements, which in Canada include having a dedicated CVA desk and being able to compute CVA RWAs at least monthly, as well as on request. Regulators can grant SA-CVA usage for portions of the book.

Banks that don’t seek or receive approval for the SA-CVA must use the basic approach, available in full and reduced versions. The full version has a more complex formula, but recognises the effect of counterparty credit spread hedges. On the flipside, unlike under the SA-CVA, exposure hedges are excluded, and 25% of the final requirement must still be calculated according to the reduced BA-CVA, ie, without any hedging benefit whatsoever.

Under both BA-CVA variants, a 0.65x “discount scalar” is applied to the final output, to compensate for the higher charges the approach generally produces compared with the SA-CVA.

Although FRTB came into force in Canada on November 1, 2023, banks are not required to make relevant Pillar 3 disclosures until the quarter ending October 31, 2024. Among the banks tracked by Risk Quantum, RBC opted to implement CVA disclosures early, beginning with the quarter ending January 31.

Why it matters

Yet another finicky and contentious building block of Basel III is producing a range of different outcomes. Ironically, despite not contemplating the possibility of internal models, CVA is the area where FRTB adopters may exhibit the most variability. But a lack of visibility into which dealer is using which approach complicates analysis.

Aside from RBC, only Scotiabank has provided any detail, saying in quarterly earnings it uses the SA-CVA, with a spokesperson adding that it uses the BA-CVA for a subset of the portfolio. As for RBC, a spokesperson told Risk Quantum the bank did not apply for SA-CVA but is considering doing so in the future.

As the most sophisticated dealer in Canada, it is puzzling why RBC didn’t seek regulatory permission to use the SA-CVA, which may have contained the post-FRTB inflation in charges thanks to its more generous treatment of hedges.

The bank may have waited until it was done absorbing HSBC Canada’s derivatives book – no doubt a driver of the increase in CVA RWAs, at least between February and April.

But it’s also possible its executives may have seen the SA-CVA in the same light some industry participants saw FRTB-compliant internal market RWA modelling: an expensive, tough-to-achieve privilege that was not worth the resulting benefit to capital requirements. If that’s the case, or the benefit from hedging under BA-CVA keeps slimming, the bank may start seeing some value in adopting the more sophisticated methodology.

Explore our data

Readers of Risk Quantum now have access to some of the datasets that sit behind our stories – not just the segment of data that is the focus for the story, but the full time series, for the full population of covered firms. Readers can choose the institutions they want to look at, the metrics they are interested in, and download the data in CSV format to run their own comparisons and build their own charts. Risk and capital managers told us it would be helpful for internal reporting and benchmarking, but we figured many of our readers might get something out of it.

Currently, the available data covers more than 120 banks and over 350 metrics, but we’ll be adding more throughout the year. The Risk Quantum database can be accessed here. The full list of data points currently available can be found at this page. The full range of banks covered can be viewed here.

Get in touch

Like Risk Quantum? Sign up for free to our daily newsletter and check @RiskQuantum for the latest updates.

If you have any thoughts on our latest analysis or want to suggest other ways to present and analyse the data, you can email us.

Tell me more

Canada’s top dealers boost derivatives clearing as FRTB kicks in

Canadian banks’ market RWAs spike on FRTB switch

No Canadian banks using internal models as FRTB kicks in

Basel CVA bombshell widens gulf with bank accounting

View all bank stories