IFRS quantitative finance series
CVA, DVA and Funding Adjustments in IFRS 13 Bank Valuations
Derivative valuation starts with contractual cash flows and market factors, but fair value also reflects non-performance risk. Credit valuation adjustment and debit valuation adjustment address counterparty and own credit effects; funding adjustments require careful analysis of market-participant assumptions and double counting.
Expected exposure and default
CVA combines future positive exposure, counterparty default likelihood and loss severity through time. DVA applies the corresponding logic to own non-performance risk on negative exposure. Netting and collateral affect exposure only when consistent with enforceable arrangements and valuation assumptions.
Wrong-way risk
Exposure and default are not always independent. A counterparty may weaken precisely when the derivative becomes valuable to the bank. Specific and general wrong-way risk should be identified, modelled where material and included in uncertainty assessment.
Avoid adjustment overlap
Liquidity, funding, collateral, close-out and credit effects can enter several adjustments or base curves. A valuation framework needs a clear decomposition and reconciliation so the same risk is not charged twice.
Quantitative expression
Implementation controls
- Validate exposure simulation and netting sets.
- Reconcile credit curves to observable evidence.
- Test wrong-way risk and collateral assumptions.
- Map each valuation adjustment to a distinct risk.