Under the existing risk-based capital framework, off-balance-sheet contracts are converted into credit equivalent amounts and then risk-weighted according to the identity of the obligor or counterparty. If a guarantee is associated with the transaction or if qualifying collateral has been posted (that is, generally, cash or OECD government securities), the portion of the credit equivalent amount that is covered by the guarantee or collateral may be risk-weighted according to the guarantor or the nature of the collateral.

The Basle Accord excludes exchange-traded derivative contracts from the risk-based capital framework where these contracts are subject to daily receipt and payment of cash variation margin (referred to as two-way margining) that has the effect of reducing a contract's current exposure to zero. Over-the-counter derivative contracts, however, are assessed a capital charge based on the current market value (current exposure) of each contract and an estimate of additional credit exposure (referred to as the add-on for potential future exposure) that may arise as a result of fluctuations in prices or rates. The maximum risk weight for derivative contracts is 50 percent.

The current exposure of a derivative contract is the market value of the contract if that value is positive, or zero if the market value is zero or negative. The add-on for potential future exposure is estimated by multiplying the notional principal amount of the contract by a credit conversion factor that is determined by the remaining maturity and type of contract.

Under the original Accord, each derivative contract entered into by an institution was converted into a credit equivalent amount. Institutions generally were not permitted to offset positive and negative market values of multiple contracts with a single counterparty. In July 1994, the Basle Accord was revised to recognise legally sound bilateral netting arrangements. Under the revision, institutions with such netting arrangements may offset positive and negative market values to calculate a single net current exposure for all transactions covered by the netting agreement (subject to a minimum value of zero).

Another revision to the Accord, effective as of year-end 1995, permits institutions with qualifying bilateral netting arrangements to reduce their add-on amount through application of a formula designed to recognise reductions in the volatility of current exposures resulting from netting arrangements. The formula is expressed as

where Anet is the adjusted add-on for all contracts subject to the bilateral netting contract, Agross is the sum of the gross add-ons for the contracts covered by the netting agreement, and NGR is the ratio of the net current exposure of the contracts included in the bilateral netting arrangement to the gross current exposure of those same contracts.