The credit conversion factor (CCF) is a coefficient in the field of
credit rating
A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.
...
. It is the ratio between the additional amount of a loan used in the future and the amount that could be claimed.
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
Off balance sheet (OBS), or incognito leverage, usually means an asset or debt or financing activity not on the company's balance sheet. Total return swaps are an example of an off-balance-sheet item.
Some companies may have significant amounts o ...
transactions (with the exception of derivatives) to an EAD amount and is an integral part in the European banking regulation since the
Basel II accords. In an off-balance-sheet product, the bank is obligated to provide the money to the
debtor
A debtor or debitor is a legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counterpart of this ...
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 in principle be drawn.
Example
Assume you are allowed to draw a credit of 1000 Euros of which you already got 200 Euros from your bank last month. In other words, you can still obtain 800 Euros in the current month. If you today get another credit of 500 Euros, the CCF is 500 Euros divided by 800 Euros, which evaluates to 62.5%.
Critiques
A possible drawback of the CCF is that it is backward looking (usually over a period of 12 months) which might be not appropriate for evaluating the EAD at a given time.
References
External links
* https://wiki.treasurers.org/wiki/Credit_Conversion_Factor
Treatment of trade finance under the Basel capital framework
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Financial risk
Credit risk