Calculation of risk-weighted exposure amounts for off-balance exposure in case of Unfunded Credit Protection (UFCP)

What is the correct treatment in cases where the consideration of CRM according to articles 235, 235a or 236 leads to higher calculated risk-weighted exposure amounts than those calculated without considering CRM, even when the risk weight of the protection provider is lower?

Under Article 193(1), it is stipulated that “no exposure in respect of which an institution obtains credit risk mitigation shall produce a higher risk-weighted exposure amount or expected loss amount than an otherwise identical exposure in respect of which an institution has no credit risk mitigation”.  However, for off-balance exposures with partial unfunded credit protection (except those treated under A-IRB where direct exposures to the protection provider are treated under IRB), and where the potential amount of unfunded credit protection (UFCP) is small relative to the estimated unconverted off-balance sheet exposure, the risk-weighted exposure amount calculated without considering credit risk mitigation exceeds that calculated according to articles 235, 235a or 236 (as applicable), whereas these articles stipulate that institutions “ shall calculate the risk-weighted exposure amounts” in accordance with the given formulae. This situation arises from the requirement to apply a 100% Credit Conversion Factor (CCF) for the calculation of the protected and unprotected parts of an exposure under Articles 235, 235a, and 236, irrespective of the CCF values prescribed under Articles 111 and 166.  Therefore, in such cases it is unclear how institutions should consider UFCP in the calculation of risk-weighted exposure amounts without contradicting article 193(1). In more detail, the risk-weighted exposure amount for a direct exposure to the obligor without considering CRM can be written as RWA obligor = r x (E on + CCF x E off ) whereas the risk-weighted exposure amount for an exposure accounting for the effect of UFCP can be written as RWA CRM = r x (E on + 100% x E off – G A ) + g x G A (in the case that E on + 100% x E off > G A ), where in either case G A , E on , E off , g and r represent the amount of credit protection, the on- and off-balance exposure amount, the risk weight applicable to a direct exposures to the protection provider, and the risk weight of exposures to the obligor, respectively. Thus, for the risk weight of the obligor without CRM (RWA obligor ) to be greater than the risk weight when a cover is considered (RWA CRM ), in accordance with article 193(1): RWA obligor > RWA CRM ↔ r x (E on + CCF x E off ) > (E on + 100% x E off   – G A ) + g x G A ↔ r x CCF x E off > r x E off – G A x (r – g) ↔ G A > (100% – CCF) x E off x r / (r – g)