Credit Valuation Adjustment
For Over–the-Counter (OTC) derivatives, in addition to the default risk capital requirements for counterparty credit risk, firms must calculate an additional capital charge to cover the risk of mark-to-market losses associated with deterioration in the creditworthiness of the counterparty. As the counterparty’s financial position worsens, the market value of its derivatives obligation declines, even though there might not be an actual default. During the 2008 financial crisis the Credit Valuation Adjustment risk was a greater source of losses than those arising from outright defaults.
'Credit Valuation Adjustment' or 'CVA' means an adjustment to the mid-market valuation of the portfolio of transactions with a counterparty. That adjustment reflects the current market value of the credit risk of the counterparty to the institution. The adjustment does not reflect the current market value of the credit risk of the institution to the counterparty (also known as Debit Valuation Adjustment –DVA). (CRR - Article 381).
An overview of the CVA calculation and an example of how this impacts capital requirements based on the CRR rules is provided in the link below.