The attribution of capital to foreign banking permanent establishments in the UK: The approach in determining an adjustment to funding costs - STEP 2: Risk weighting the assets: over-the-counter derivatives
The risk with OTC derivatives lies in having to replace any positive cash flows following the failure of a counter party. The exposure from OTC derivatives is dealt with under the same broad framework as other off-balance sheet contracts with the contract’s cash equivalent amount (CEA) being multiplied by the risk weight appropriate to the counter party to determine the risk-weighted amount for the contract. The difference with the treatment of other derivatives lies in the way in which the CEA is calculated. For further details consult the derivatives chapter in the Interim Prudential Source Book for Banks (IPRU (BANK)).