FRM Exam Part II · Basel III: Finalising Post-crisis Reforms

Basel III CVA Risk Framework: BA-CVA and SA-CVA Explained

Updated 11 October 2026 · Fact-checked

CVA risk is the risk of mark-to-market losses on derivative counterparty credit valuation adjustments, caused by changes in counterparty credit spreads and exposure drivers. The revised Basel III framework gives banks two approaches: the basic approach (BA-CVA) and the sensitivities-based standardised approach (SA-CVA). The internal model approach is removed. Pick the approach, then apply its formula.

Understand Credit Valuation Adjustment (CVA) Risk Framework

Credit valuation adjustment (CVA) is the market price of counterparty default risk on a derivative. It is the difference between the value of a trade with a risk-free counterparty and its value with the real counterparty. Banks book CVA as a fair-value adjustment, so it moves every day.

The Basel CVA risk capital charge covers the mark-to-market losses on CVA, not default losses. Default losses sit in the counterparty credit risk (CCR) charge. CVA risk comes from two sources: movements in the counterparty's credit spread, and movements in the market risk factors that drive the exposure, such as interest rates, FX and equity prices. The 2008 crisis showed that most CCR losses came from CVA marks, not from actual defaults. That is why the capital charge exists.

The finalised framework removes the internal model approach. The earlier advanced (VaR-based) CVA approach and the older standardised CVA approach are gone. Regulators did not trust internal CVA models to be consistent across banks. Banks now choose between two methods.

BA-CVA is a formula based on counterparty risk weights, effective maturity and exposure at default (EAD). It has a reduced version with no hedge recognition and a full version that recognises eligible CVA hedges. SA-CVA is sensitivities-based. It needs supervisory approval. It uses the bank's own CVA sensitivities to risk factors, which are then given regulatory risk weights and correlations, similar in spirit to the FRTB standardised approach. SA-CVA covers interest rate, FX, counterparty credit spread, reference credit spread, equity and commodity risk classes.

There are also scope rules. Transactions with a qualifying central counterparty are excluded. Securities financing transactions are excluded unless the supervisor sees material CVA loss exposure. A bank with aggregate notional of non-centrally cleared derivatives at or below €100 billion may elect to set its CVA capital equal to 100% of its CCR capital requirement.

Key formulas to remember

Standalone CVA capital per counterparty (BA-CVA): SCVA_c = (1 ÷ α) × RW_c × Σ over netting sets (M_NS × EAD_NS × DF_NS); α = 1.4. RW_c is the supervisory risk weight set by sector and credit quality (investment grade or high yield/unrated). DF_NS = 1 for banks using SA-CCR for EAD. For IMM banks, DF_NS = (1 − e^(−0.05 × M_NS)) ÷ (0.05 × M_NS).
Reduced BA-CVA aggregation: K_reduced = √[(ρ × Σ SCVA_c)² + (1 − ρ²) × Σ SCVA_c²]; ρ = 50%. The first term is the systematic part. The second is the idiosyncratic part. Sums run over all counterparties.
BA-CVA capital charge, reduced version: K_BA-CVA = DS × K_reduced, with DS = 0.65; DS is a supervisory scalar. Risk-weighted assets (RWA) = 12.5 × K.
Full BA-CVA: K_full = β × K_reduced + (1 − β) × K_hedged, with β = 0.25; Then K_BA-CVA = DS × K_full. K_hedged reflects eligible hedges: single-name CDS, single-name contingent CDS and index CDS. Hedge recognition is limited and includes a hedge-misalignment penalty.
Small-book election: CVA capital = 100% × CCR capital requirement; Available only if aggregate notional of non-centrally cleared derivatives ≤ €100 billion and the supervisor permits it.
SA-CVA structure: K_SA-CVA = m_CVA × Σ over risk classes (delta and vega capital); m_CVA is a multiplier set at 1 unless the supervisor raises it. Counterparty credit spread has delta only. Each risk class aggregates by buckets with prescribed risk weights and correlations.

How to solve Credit Valuation Adjustment (CVA) Risk Framework questions

Use this method for any CVA framework question, whether it asks for a number or for a concept.

1Read the scope first. Check whether the trades are with a qualifying CCP or are SFTs, as these are normally excluded from CVA capital.
2Identify the approach: SA-CVA (needs supervisory approval), BA-CVA, or the small-book election at 100% of CCR capital. Remember there is no internal model approach.
3For BA-CVA, compute SCVA for each counterparty: take RW × M × EAD × DF for each netting set, sum them, then divide by 1.4.
4Aggregate using ρ = 50%: square the sum of SCVA times ρ, add (1 − ρ²) times the sum of squared SCVA, then take the square root.
5Apply DS = 0.65. If hedges are in play and the full version is used, blend K_reduced and K_hedged with β = 0.25 first.
6Convert to RWA by multiplying by 12.5 if the question asks for risk-weighted assets.
7For SA-CVA questions, name the risk classes, note delta and vega, and remember the sensitivities come from the bank's own CVA model.
8Check the interpretation: state that the charge covers CVA mark-to-market volatility, not default loss.

Quickest way: Approach-selection shortcut

When to use it: Use this for conceptual or comparison MCQs where you must pick the right approach or statement fast.

Ask: does the bank have SA-CVA approval? If yes, SA-CVA. If no, BA-CVA.
Ask: is notional of non-cleared derivatives ≤ €100bn and is the election allowed? If yes, capital can be 100% of CCR capital.
Eliminate any option that mentions an internal model or advanced CVA approach. These are removed.
Eliminate any option that applies CVA capital to QCCP trades.
For numbers, remember the constants: α = 1.4, ρ = 50%, DS = 0.65, β = 0.25, RWA = 12.5 × K. Check the answer with SCVA values first, then the square root.

Common mistakes in Credit Valuation Adjustment (CVA) Risk Framework

Saying banks can still use an internal model approach for CVA.
The earlier Basel III text had an advanced VaR-based CVA approach, and older notes still describe it.
Fix: Remember the finalised framework offers only BA-CVA and SA-CVA. Internal models are removed.
Forgetting to divide by α = 1.4 when computing SCVA.
Students focus on RW × M × EAD and treat that as the final value.
Fix: Write the formula with 1 ÷ 1.4 at the front every time.
Summing SCVA across counterparties and stopping.
It feels like standalone charges should simply add.
Fix: Use the ρ = 50% aggregation. It is below the simple sum because idiosyncratic parts diversify.
Applying the discount factor of 1 to IMM banks, or the exponential formula to SA-CCR banks.
Students mix up which EAD method triggers the discount factor.
Fix: SA-CCR banks use DF = 1. Only IMM banks use (1 − e^(−0.05M)) ÷ (0.05M).
Treating the CVA charge as covering default loss.
The words 'credit' and 'capital' suggest default risk.
Fix: CVA capital covers mark-to-market losses from spread and exposure-driver moves. Default loss is in the CCR charge.
Forgetting DS = 0.65 or the 12.5 factor.
Students stop at the square root.
Fix: Use a checklist: SCVA, aggregate, × DS, × 12.5 for RWA.

Worked examples

Example 1

A bank uses SA-CCR and applies reduced BA-CVA. It has two counterparties. Counterparty A: financial, investment grade (RW 5%), one netting set with M = 2 years and EAD $70 million. Counterparty B: financial, investment grade (RW 5%), one netting set with M = 4 years and EAD $70 million. Using α = 1.4, ρ = 50% and DS = 0.65, find the CVA capital charge and RWA.

Show the solution

SA-CCR bank, so DF = 1.
SCVA_A = (1 ÷ 1.4) × 0.05 × 2 × 70 = 7 ÷ 1.4 = $5 million.
SCVA_B = (1 ÷ 1.4) × 0.05 × 4 × 70 = 14 ÷ 1.4 = $10 million.
Sum of SCVA = 15. ρ × sum = 7.5. Squared = 56.25.
Sum of squared SCVA = 25 + 100 = 125. (1 − 0.25) × 125 = 93.75.
K_reduced = √(56.25 + 93.75) = √150 = 12.247.
K_BA-CVA = 0.65 × 12.247 = 7.961.
RWA = 12.5 × 7.961 = 99.5.

Answer: CVA capital ≈ $7.96 million; RWA ≈ $99.5 million.

Example 2

A bank has no SA-CVA approval. Its aggregate notional of non-centrally cleared derivatives is €90 billion, and its CCR capital requirement is $200 million. The supervisor permits the small-book election. What is its CVA capital charge? A) $0 B) $100 million C) $200 million D) $260 million

Show the solution

Check the threshold: €90 billion is below the €100 billion limit, so the bank may elect the simplified treatment.
Under the election, CVA capital equals 100% of the CCR capital requirement.
100% × $200 million = $200 million.
Option A ignores CVA risk. Option B uses 50%, which is not the rule. Option D invents a multiplier.

Answer: C) $200 million.

Exam tips

Know the approach hierarchy: SA-CVA with approval, otherwise BA-CVA, and the small-book election for banks at or below €100 billion notional. Questions often test which one fits a described bank.
Expect statements that mention an internal model. Mark them false because the internal model approach is removed.
In calculation questions, track the constants: 1.4, 50%, 0.65, 0.25, 12.5. Most wrong options come from skipping one.
Be ready to name SA-CVA risk classes and say that sensitivities come from the bank's CVA pricing model, with delta and vega capital.
For hedge questions, state the eligible BA-CVA hedges: single-name CDS, single-name contingent CDS and index CDS.

Practice questions from Basel III: Finalising Post-crisis Reforms

Credit Valuation Adjustment (CVA) Risk Framework: frequently asked questions

What is the difference between BA-CVA and SA-CVA?

BA-CVA is a formula using supervisory risk weights, maturity and EAD per counterparty. SA-CVA is sensitivities-based, uses the bank's CVA model sensitivities and requires supervisory approval. SA-CVA is more risk-sensitive and recognises hedges more fully.

Why did Basel remove the internal model approach for CVA?

Regulators were concerned about the variability of results across banks and the difficulty of validating internal CVA models. The sensitivities-based standardised approach keeps risk sensitivity while improving comparability.

Does CVA capital cover counterparty default?

No. CVA capital covers mark-to-market losses on the credit valuation adjustment. Default loss on the counterparty is covered by the separate counterparty credit risk capital charge.

Which trades are excluded from CVA capital?

Transactions with a qualifying central counterparty are excluded. Securities financing transactions are also excluded unless the supervisor judges the CVA loss exposure to be material.