Funded Bilateral Valuation Adjustment

TL;DR

This paper introduces the Funded Bilateral Valuation Adjustment (FBVA), linking funding costs of collateral to counterparty risk, and suggests it as a method to restructure and potentially reduce capital charges in uncollateralized transactions.

Contribution

It defines the FBVA concept, connecting funding costs with bilateral default probabilities, and proposes it as a tool for risk restructuring under Basel III regulations.

Findings

FBVA aligns funding costs with bilateral default risk.

It offers a way to mitigate Basel III capital charges.

The approach provides a new perspective on counterparty risk management.

Abstract

We show how the cost of funding the collateral in a particular set up can be equal to the Bilateral Valuation Adjustment with the "funded" probability of default, leading to the definition of a Funded Bilateral Valuation Adjustment (FBVA). That set up can also be viewed by an investor as an effective way to restructure the counterparty risk arising from an uncollateralized transaction with a counterparty, mitigating or even avoiding entirely the additional capital charge introduced by the new Basel III framework.