2. The minimum capital requirement is expressed in terms of two separately calculated charges, one applying to the "specific risk" of each security, whether it is a short or a long position, and the other to the interest rate risk in the portfolio (termed "general market risk") where long and short positions in different securities or instruments can be offset. An example of how general market risk is to be calculated is set out in C.2.

I. Specific risk

3. The capital charge for specific risk is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer. In measuring the risk, offsetting will be restricted to matched positions in the identical issue (including positions in derivatives). Even if the issuer is the same, no offsetting will be permitted between different issues since differences in coupon rates, liquidity, call features, etc. mean that prices may diverge in the short run.

4. The specific risk charge is graduated in five broad categories as follows:

government	0.00%
qualifying	0.25% (residual term to final maturity 6 months or less)
	1.00% (residual term to final maturity between 6 and 24 months)
	1.60% (residual term to final maturity exceeding 24 months)
other	8.00%

5. The category "government" will include all forms of government paper including bonds, Treasury bills and other short-term instruments, but national authorities reserve the right to apply a specific risk weight to securities issued by certain foreign governments, especially to securities denominated in a currency other than that of the issuing government.

6. The "qualifying" category includes securities issued by public sector entities and multilateral development banks, plus other securities that are:

• rated investment-grade by at least two credit rating agencies specified by the national authority; or
• rated investment-grade by one rating agency and not less than investment-grade by any other rating agency specified by the national authority (subject to supervisory oversight); or
• subject to supervisory approval, unrated, but deemed to be of comparable investment quality by the reporting bank, and the issuer has securities listed on a recognised stock exchange.

Each supervisory authority will be responsible for monitoring the application of these qualifying criteria, particularly in relation to the last criterion where the initial classification is essentially left to the reporting banks. National authorities will also have discretion to include within the qualifying category debt securities issued by banks in countries which have implemented the present Accord, subject to the express understanding that supervisory authorities in such countries undertake prompt remedial action if a bank fails to meet the capital standards set forth in the Accord. Similarly, national authorities will have discretion to include within the qualifying category debt securities issued by securities firms that are subject to equivalent rules.

7. The "other" category will receive the same specific risk charge as a private-sector borrower under the credit risk requirements, i.e., 8%. However, since this may in certain cases considerably underestimate the specific risk for debt securities which have a high yield to redemption relative to government debt securities, each member country will have the discretion:

• to apply a specific risk charge higher than 8% to such securities; and/or
• to disallow offsetting for the purposes of defining the extent of general market risk (see paragraph 13 below) between such securities and any other debt securities.

II. General market risk

8. The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates. A choice between two principal methods of measuring the risk is permitted, a "maturity" method and a "duration" method. In each method, the capital charge is the sum of four components:

• the net short or long position in the whole trading book;
• a small proportion of the matched positions in each time-band (the "vertical disallowance");
• a larger proportion of the matched positions across different time-bands (the "horizontal disallowance");
• a net charge for positions in options, where appropriate (see A.5).

9. Separate maturity ladders should be used for each currency and capital charges should be calculated for each currency separately and then summed with no offsetting between positions of opposite sign. In the case of those currencies in which business is insignificant, separate maturity ladders for each currency are not required. Rather, the bank may construct a single maturity ladder and slot, within each appropriate time-band, the net long or short position for each currency. However, these individual net positions are to be summed within each time-band, irrespective of whether they are long or short positions, to produce a gross position figure.

10. In the maturity method (see paragraph 14 for the duration method), long or short positions in debt securities and other sources of interest rate exposures including derivative instruments are slotted into a maturity ladder comprising thirteen time-bands (or fifteen time-bands in case of low coupon instruments). Fixed rate instruments should be allocated according to the residual term to maturity and floating-rate instruments according to the residual term to the next repricing date. Opposite positions of the same amount in the same issues (but not different issues by the same issuer), whether actual or notional, can be omitted from the interest rate maturity framework, as well as closely matched swaps, forwards, futures and FRAs which meet the conditions set out in paragraphs 20 and 21 below.

11. The first step in the calculation is to weight the positions in each time-band by a factor designed to reflect the price sensitivity of those positions to assumed changes in interest rates. The weights for each time-band are set out in Table 1 below. Zero-coupon bonds and deep-discount bonds (defined as bonds with a coupon of less than 3%) should be slotted according to the time-bands set out in the second column of the table.

12. The next step in the calculation is to offset the weighted longs and shorts in each time-band, resulting in a single short or long position for each band. Since, however, each band would include different instruments and different maturities, a 10% capital charge to reflect basis risk and gap risk will be levied on the smaller of the offsetting positions, be it long or short. Thus, if the sum of the weighted longs in a time-band is $100 million and the sum of the weighted shorts $90 million, the so-called "vertical disallowance" for that time-band would be 10% of $90 million (i.e., $9.0 million).

Coupon 3% or more	Coupon less than 3%	Risk weight	Assumed changes in yield
1 month or less	1 month or less	0.00%	1.00
1 to 3 months	1 to 3 months	0.20%	1.00
3 to 6 months	3 to 6 months	0.40%	1.00
6 to 12 months	6 to 12 months	0.70%	1.00
1 to 2 years	1.0 to 1.9 years	1.25%	0.90
2 to 3 years	1.9 to 2.8 years	1.75%	0.80
3 to 4 years	2.8 to 3.6 years	2.25%	0.75
4 to 5 years	3.6 to 4.3 years	2.75%	0.75
5 to 7 years	4.3 to 5.7 years	3.25%	0.70
7 to 10 years	5.7 to 7.3 years	3.75%	0.65
10 to 15 years	7.3 to 9.3 years	4.50%	0.60
15 to 20 years	9.3 to 10.6 years	5.25%	0.60
over 20 years	10.6 to 12 years	6.00%	0.60
	12 to 20 years	8.00%	0.60
	over 20 years	12.50%	0.60

13. The result of the above calculations is to produce two sets of weighted positions, the net long or short positions in each time-band ($10 million long in the example above) and the vertical disallowances, which have no sign. In addition, however, banks will be allowed to conduct two rounds of "horizontal offsetting", first between the net positions in each of three zones (zero to one year, one year to four years and four years and over), and subsequently between the net positions in the three different zones. The offsetting will be subject to a scale of disallowances expressed as a fraction of the matched positions, as set out in Table 2 below. The weighted long and short positions in each of three zones may be offset, subject to the matched portion attracting a disallowance factor that is part of the capital charge. The residual net position in each zone may be carried over and offset against opposite positions in other zones, subject to a second set of disallowance factors.

Zones	Time-band	within the zone	between adjacent zones	between zones 1 and 3
	0 - 1 month
Zone 1	1 - 3 months	40%
	3 - 6 months
	6 - 12 months		40%
	1 - 2 years
Zone 2	2 - 3 years	30%		100%
	3 - 4 years
	4 - 5 years		40%
	5 - 7 years
Zone 3	7 - 10 years
	10 - 15 years	30%
	15 - 20 years
	over 20 years

14. Under the alternative duration method, banks with the necessary capability may, with their supervisors' consent, use a more accurate method of measuring all of their general market risk by calculating the price sensitivity of each position separately. Banks must elect and use the method on a continuous basis (unless a change in method is approved by the national authority) and will be subject to supervisory monitoring of the systems used. The mechanics of this method are as follows:

• first calculate the price sensitivity of each instrument in terms of a change in interest rates of between 0.6 and 1.0 percentage points depending on the maturity of the instrument (see Table 3 below);

• slot the resulting sensitivity measures into a duration-based ladder with the fifteen time-bands set out in Table 3;

• subject long and short positions in each time-band to a 5% vertical disallowance designed to capture basis risk;

• carry forward the net positions in each time-band for horizontal offsetting subject to the disallowances set out in Table 2.

	Assumed change in yield		Assumed change in yield
Zone 1		Zone 3
1 month or less	1.00	3.6 to 4.3 years	0.75
1 to 3 months	1.00	4.3 to 5.7 years	0.70
3 to 6 months	1.00	5.7 to 7.3 years	0.65
6 to 12 months	1.00	7.3 to 9.3 years	0.60
		9.3 to 10.6 years	0.60
Zone 2		10.6 to 12 years	0.60
1.0 to 1.9 years	0.90	12 to 20 years	0.60
1.9 to 2.8 years	0.80	over 20 years	0.60
2.8 to 3.6 years	0.75

15. In the case of residual currencies (see paragraph 9 above) the gross positions in each time-band will be subject to either the risk weightings set out in Table 1, if positions are reported using the maturity method, or the assumed change in yield set out in Table 3, if positions are reported using the duration method, with no further offsets.

III. Interest rate derivatives

16. The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book which react to changes in interest rates, (e.g., forward rate agreements (FRAs), other forward contracts, bond futures, interest rate and cross-currency swaps and forward foreign exchange positions). Options can be treated in a variety of ways as described in A.5. A summary of the rules for dealing with interest rate derivatives is set out in Table 4 at the end of this section.

1. Calculation of positions

17. The derivatives should be converted into positions in the relevant underlying and become subject to specific and general market risk charges as described above. In order to calculate the standard formula described above, the amounts reported should be the market value of the principal amount of the underlying or of the notional underlying.

(a) Futures and forward contracts, including forward rate agreements

18. These instruments are treated as a combination of a long and a short position in a notional government security. The maturity of a future or a FRA will be the period until delivery or exercise of the contract, plus - where applicable - the life of the underlying instrument. For example, a long position in a June three month interest rate future (taken in April) is to be reported as a long position in a government security with a maturity of five months and a short position in a government security with a maturity of two months. Where a range of deliverable instruments may be delivered to fulfil the contract, the bank has flexibility to elect which deliverable security goes into the maturity or duration ladder but should take account of any conversion factor defined by the exchange. In the case of a future on a corporate bond index, positions will be included at the market value of the notional underlying portfolio of securities.

(b) Swaps

19. Swaps will be treated as two notional positions in government securities with relevant maturities. For example, an interest rate swap under which a bank is receiving floating rate interest and paying fixed will be treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed-rate instrument of maturity equivalent to the residual life of the swap. For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g., a stock index, the interest rate component should be slotted into the appropriate repricing maturity category, with the equity component being included in the equity framework. The separate legs of cross-currency swaps are to be reported in the relevant maturity ladders for the currencies concerned.

2. Calculation of capital charges for derivatives under the standardised methodology

(a) Allowable offsetting of matched positions

20. Banks may exclude from the interest rate maturity framework altogether (for both specific and general market risk) long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity. A matched position in a future or forward and its corresponding underlying may also be fully offset, and thus excluded from the calculation. When the future or the forward comprises a range of deliverable instruments offsetting of positions in the future or forward contract and its underlying is only permissible in cases where there is a readily identifiable underlying security which is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the "cheapest-to-deliver", and the price of the future or forward contract should in such cases move in close alignment. No offsetting will be allowed between positions in different currencies; the separate legs of cross-currency swaps or forward foreign exchange deals are to be treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency.

21. In addition, opposite positions in the same category of instruments can in certain circumstances be regarded as matched and allowed to offset fully. To qualify for this treatment the positions must relate to the same underlying instruments, be of the same nominal value and be denominated in the same currency. In addition:

1. for futures: offsetting positions in the notional or underlying instruments to which the futures contract relates must be for identical products and mature within seven days of each other;
2. for swaps and FRAs: the reference rate (for floating rate positions) must be identical and the coupon closely matched (i.e., within 15 basis points); and
3. for swaps, FRAs and forwards: the next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits:
   • less than one month hence: same day;
   • between one month and one year hence: within seven days;
   • over one year hence: within thirty days.

22. Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the payments required by the swap into their present values. For that purpose, each payment should be discounted using zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time-band using procedures that apply to zero (or low) coupon bonds; these figures should be slotted into the general market risk framework as set out earlier. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the maturity or duration method and allocate these sensitivities into the time-bands set out in Table 1 or

Table 3. Other methods which produce similar results could also be used. Such alternative treatments will, however, only be allowed if:

• the supervisory authority is fully satisfied with the accuracy of the systems being used;
• the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time-bands;
• the positions are denominated in the same currency.

  (b) Specific risk

23. Interest rate and currency swaps, FRAs, forward foreign exchange contracts and interest rate futures will not be subject to a specific risk charge. This exemption also applies to futures on an interest rate index (e.g., LIBOR). However, in the case of futures contracts where the underlying is a debt security, or an index representing a basket of debt securities, a specific risk charge will apply according to the credit risk of the issuer as set out in paragraphs 3­7 above.

(c) General market risk

24. General market risk applies to positions in all derivative products in the same manner as for cash positions, subject only to an exemption for fully or very closely matched positions in identical instruments as defined in paragraphs 20 and 21. The various categories of instruments should be slotted into the maturity ladder and treated according to the rules identified earlier.

Instrument	Specific risk charge	General market risk charge
Exchange-traded future
Government debt security	No	Yes, as two positions
Corporate debt security	Yes	Yes, as two positions
Index on interest rates (e.g., LIBOR)	No	Yes, as two positions
OTC forward
Government debt security	No	Yes, as two positions
Corporate debt security	Yes	Yes, as two positions
Index on interest rates	No	Yes, as two positions
FRAs, Swaps	No	Yes, as two positions
Forward foreign exchange	No	Yes, as one position in each currency
Options		Either
- Government debt security	No	(a) Carve out together with the associated hedging positions simplified approach scenario analysis internal models (Part B)
Corporate debt security Index on interest rates FRAs, Swaps	Yes No No	(b) General market risk charge according to the delta-plus method (gamma and vega should receive separate capital charges)