Regulatory treatment of valuation adjustments to derivative liabilities (Amendment to Basel III framework)
The Basel Committee on Banking Supervision revised paragraph 75 of Basel III as regards its application to derivatives. The Basel III rule in paragraph 75 is designed to ensure that an increase in the credit risk of a bank does not, via a reduction in the value of its liabilities, lead to an increase in its common equity. Paragraph 75 required banks to "derecognise in the calculation of Common Equity Tier 1, all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank's own credit risk." While this rule was originally developed in the context of debt instruments issued by banks, the principle extends also to fair valued OTC derivatives. However, the application of paragraph 75 to derivatives was not straightforward.