Credit conversion factor

The credit conversion factor (CCF) is a coefficient in the field of credit rating, it is the ratio between the additional amount of a loan used in the future divided by the amount that could be claimed.[1]

Background

The key variables for (credit) risk assessment are the probability of default (PD), the Loss given default (LGD) and the Exposure at default (EAD). The credit conversion factor calculates the amount of a free credit line and other off-balance-sheet transactions (with the exception of derivatives) to an EAD amount[2] and is an integral part in the European banking regulation since the Basel II accords. In an off-balance-sheet product, the bank obligated to provide the money to the debtor once the need arises. To calculate the amount of money lost in the case of a default, it is common practice to weight the amount of future obligations with those which could be in principle drawn.

Example

Assume you are allowed to draw a credit of 1000 Euro of which you already got 200 Euro from your bank last month. In other words, you can still obtain 800 Euro in the current month. If you today get another credit of 500 Euro, the CCF is 500 Euro divided by 800 Euro, which evaluates to 62.5%.

Critics

A possible drawback of the CCF that it is backward looking (usually over a period of 12 months) which might be not appropriate for valuating the EAD at a given time.[3]

References

  1. ^“Loss estimation”. RSU Rating Service Unit. Retrieved 14 December 2018.
  2. ^“Calculation of the Credit Conversion Factor (CCF)”. help.sap.com. SAP SE. Retrieved 14 December 2018.
  3. ^Taplin, Ross; To, Huong Minh; Hee, Jarrad (2007). “Modeling exposure at default, credit conversion factors and the Basel II Accord”. The Journal of Credit Risk. 3 (2): 75–84. doi:10.21314/JCR.2007.064. Retrieved 14 December 2018.

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