General value adjustment as a performance indicator – profit and loss account and equity
Counterparty risks and their interdependencies in accounting, risk management and regulatory reporting: general value adjustment (GVA)
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General value adjustment as a performance indicator – profit and loss account and equity
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Rising insolvency rates and provisions for risks at financial institutions
Geopolitical tensions, structural shifts in key economic sectors and increased macroeconomic volatility are increasingly affecting banks’ loan portfolios. These effects are not isolated but systematic. In this environment, corporate insolvency rates have risen to a level last seen in 2005. For consumer insolvencies, comparable figures were last reached in 2016. For management, this development marks a changed starting point:
Counterparty risks are no longer an isolated issue within risk controlling, they have a direct impact on the institution’s profitability, capital adequacy and strategic flexibility.
Risk provisioning as a performance indicator and within the IT landscape
Credit institutions now have sophisticated, partly AI-supported processes for processing credit, collateral and ESG data. These provide detailed ratings, probabilities of default and loss rates. For the board and senior management, however – in addition to the complexity of the models – it is crucial to translate this information consistently into reliable profit and loss, capital and risk forecasts. It is only at this level that counterparty risk metrics become effective control indicators.
Rising counterparty risks always have an impact through several channels simultaneously: via impairment charges in the profit and loss account, via capital requirements, and via the available risk coverage capacity. Risk management, profit management and capital allocation are therefore closely interlinked and cannot be managed independently of one another.
General value adjustment: Interdependencies
For HGB institutions, general value adjustments and specific provisions in particular represent a key lever in this integrated management system. They not only influence the profit or loss for the period, but also have a direct impact on the level and development of eligible capital. This first article in the series “Counterparty risks as a performance indicator” focuses on general value adjustments. The following articles will examine further counterparty risk indicators, including in the context of loss-free valuation.
From the perspective of counterparty risk, general value adjustments form a key link between accounting, supervisory law and strategic corporate management. The challenge for management lies – in addition to optimising individual key performance indicators – in consistently managing their interdependency.
Even the choice of calculation method for general value adjustments (GVA) in accounting can have significant implications. For institutions with stable credit quality, the BFA 7 recognition method often results in lower GVA levels than the simplified twelve-month expected loss method. Provided that credit quality does not deteriorate significantly, the recognition method does not generally give rise to any additional GVA requirements.
In terms of capital management, different effects arise depending on the regulatory approach. Whilst for CRSA institutions, general value adjustments initially reduce Common Equity Tier 1 capital but may increase Tier 2 capital within certain limits, for IRB institutions they lead to immediate adjustments to regulatory capital via the expected loss reconciliation. For CRSA institutions, the choice of the GVA approach must therefore always be assessed from a capital perspective as well.
Furthermore, through their impact on own funds, general value adjustments are of significant importance for the normative perspective of capital planning. They must be consistently forecast and taken into account in the adverse scenarios required by regulatory standards.
Optimisation approaches in the area of general value adjustments – such as the choice of calculation method – must therefore not be considered in isolation. Rather, all three channels of bank management must always be taken into account: accounting, the regulatory capital calculation (Pillar I) and the determination of risk coverage potential in regulatory risk management (Pillar II).
General value adjustment: complexity of calculation
If one examines the calculation logic behind the underlying metrics, a clear distinction can be made based on the complexity of the calculations. The twelve-month expected loss is relatively straightforward to calculate and is sufficient for simplified methods of general value adjustment as well as for IRB reconciliation. However, present-value lifetime metrics are required for the targeted optimisation of general value adjustments. These necessitate explicit consideration of residual maturities, credit ageing and yield curve effects. The decisive leap in management lies in the transition from single-period to multi-period approaches. The offsetting of credit spreads is an integral part of the multi-period logic.
For efficient implementation, the use of specialised BFA-7 tools is recommended. They enhance the methodological consistency of the calculation, particularly through the explicit modelling of non-linear effects and multi-period relationships. Furthermore, they facilitate the performance of scenario analyses required by regulatory authorities – for example, in the context of ESG risks – and improve the predictive power of the general value adjustment in planning.
General value adjustment in business management
It is particularly in forecasting and multi-year planning that the complexity of these and other interdependencies becomes starkly apparent. At this stage strategic decisions take operational effect. Against a backdrop of rising default rates, counterparty risks are therefore coming increasingly into focus in corporate planning as well.
An initial, obvious approach to optimisation lies in the appropriate structuring of the general value adjustment and in the deliberate management of their interdependencies within accounting, regulatory reporting and strategic planning.
The general value adjustment thus represents a key link between accounting, supervisory law and strategic management – and is one of the key levers for robust, forward-looking corporate governance.
| Use Case | Context | Key figure | Model structure | Control-related degrees of freedom |
Stress scenarios |
| IRB reconciliation of own funds calculation | Regulatory reporting and risk controlling |
IRB benchmark: 12-month EL |
Single-period | Low degrees of freedom (purely input-driven) | Parameter-Stress (PD/LGD/EAD) |
| The CRSA-GVA effect on equity | Regulatory reporting and risk controlling |
GVA (depending on the GVA process) |
Single- or multi-period, depending on the method |
High degrees of freedom (mode selection in the GVA method) | Parameter stress; path stress where applicable |
| GVA under BFA7 simplified procedure |
Accounting | GVA ≈ 12-month EL |
Single-period | Low degrees of freedom (purely input-driven) | Parameter stress |
| GVA according to BFA7 credit transfer procedure |
Accounting | Lifetime EL and credit rating premium path |
Multi-period PD, LGD, EAD, yield curve, initial rating, etc. |
High degrees of freedom (choice of operating mode + path structure) | Parameter stress; path stress where applicable |
Table 1: GVA and its impact on accounting, regulatory reporting and risk controlling
The control effect of the general value adjustment arises not only from the fine-tuning of individual parameters, but also from the choice of model regime, which determines the time structure, type of key figure and degree of control.
Outlook
These interdependencies are not limited to general value adjustments. In the following posts in this blog series, we will examine, amongst other things, the migration-based treatment of counterparty risks in planning, business unit management and regulatory capital planning in a context of heightened geopolitical uncertainty.
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