A group of federal agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision issued new guidance on counterparty credit risk (CCR) management to address the weaknesses observed in CCR management at many banking organizations during the financial crisis. 

The primary intent of the guidance is to revamp shortcomings in the timeliness and accuracy of exposure aggregation capabilities and the inadequate measurement of correlation risks in the industry. As noted by the agencies, the previous crisis has highlighted deficiencies in the ability of banking organizations to monitor and manage counterparty exposure limits and concentration risks, citing poor selection of risk metrics and inadequate system infrastructure.   

The guidance emphasizes that banking organizations should use appropriate reporting metrics and exposure limits systems, have well-developed and comprehensive stress testing, and maintain systems that facilitate measurement and aggregation of CCR across the organization. The guidance also includes a call for sound practices for risk control functions including validating models and systems, ensuring independent risk management and internal audit processes, and managing legal and operational risks.

“Banking organizations should comprehensively evaluate existing practices against the standards in this guidance and implement remedial action as appropriate,” the announcement noted.

Among the important topics highlighted in the guidance include:

Governance: The role of board of directors to clearly define organization's risk tolerance of CCR, the frequency of reporting the risk to management, appropriate allocation of resources to risk management and incorporate internal audit assessment of its CCR framework as part of the regular audit plan.

Risk Measurement: Metrics selection, aggregation of exposures and credit valuation adjustments are among the indicators highlighted by the agencies to effectively measure risks undertaken by banks.

Risk Management: Addressed the needs for bank to establish meaningful counterparty limits, margins policies and practices, and on-going validation of its CCR models. 

Issues on legal and operational risks are also addressed in the guidance.