Quantifying the Risk Equivalency Process

By now the reader should be aware of the importance of the risk equivalency process in determining product risk and allocating the correct amount of risk exposure to a given transaction; the development of an accurate risk equivalency gauge is an important component in the measurement stage of the risk management process. It is vital at this point to understand thoroughly the basis for the derivation of our risk factor variable RF, discussed in Chapter 5. Remember that the risk equivalency process is applicable only in deriving potential risk equivalent exposure (REE) and is utilised only for those products or transactions which are deemed to add market risk exposure to the bank (inventory and provisional risks require no adjustments).