What is BA-CVA and when do banks use it?

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AcadiFi · Accepted Answer

BA-CVA (Basic Approach CVA) is the simpler regulatory CVA capital method for banks that don't qualify for or elect SA-CVA. It's mandatory for banks with a small derivatives book (below supervisory thresholds) and optional for others.

**Formula (reduced BA-CVA)**:

K_reduced = [(Σ_c ρ × S_c)^2 + (1 − ρ^2) × Σ_c S_c^2]^(1/2)

Where:
- S_c = risk weight × EAD × maturity factor for counterparty c
- ρ = 0.5 (supervisory correlation)
- Risk weights are prescribed by rating and sector (e.g., 0.5% for AAA sovereign, 3.0% for BB corporate, 10.0% for unrated)

**Full BA-CVA** adds recognition for eligible single-name CDS and index CDS hedges:

K_full = β × K_reduced + (1 − β) × K_hedged

Where β = 0.25 (limits hedging benefit to 75%).

Example: Cambrex Community Bank has 3 derivatives counterparties:
- Counterparty A: BBB corporate, EAD $20M, maturity 3Y → S_A = 3% × $20M × factor = $0.9M
- Counterparty B: AA bank, EAD $50M, maturity 2Y → S_B = 0.7% × $50M × factor = $0.42M
- Counterparty C: BB corporate, EAD $15M, maturity 5Y → S_C = 5% × $15M × factor = $1.5M

Aggregate with ρ = 0.5 → K_reduced ≈ $2.3M

BA-CVA pros:
- No sensitivity calculation — just EAD, rating, maturity
- No separate IT infrastructure
- No supervisory approval needed

BA-CVA cons:
- Limited hedge recognition (only CDS on counterparty or index, not market risk hedges)
- Higher capital for complex portfolios than SA-CVA
- No capital benefit for diversification across risk types

For FRM, know: BA-CVA is the 'default' method; SA-CVA requires sophisticated CVA sensitivity infrastructure. Most G-SIBs use SA-CVA.

What is BA-CVA and when do banks use it?

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