Concerning Santosh’s inquiry regarding EPE:

(For the uninitiated, “Alpha” in this instance is the ratio a bank must apply to its simulated Expected Positive Exposure (EPE) for derivatives to arrive at its loan equivalent amount. The idea is that the exposure uncertainty around the expected amount will increase the extreme loss potential compared to a static exposure of the same size.)

Own estimation of Alpha is quite a complex undertaking, since it involves simulating exposure and default simultaneously subject to supervisory review and approval of a bank’s assumptions, simulation methods and their implementation. It is likely that most banks could reduce regulatory capital somewhat by undertaking this exercise, since the mandated Alpha of 1.4 is really remarkably conservative in my experience. Despite that, I think the ancillary benefits are distinctly limited in this case. Unless this will feed into a full-blown credit VaR exercise, I don’t think it will contribute much to improving either strategic or tactical business decisions. Given the limited secondary benefits, I incline toward deciding on whether to attempt an own Alpha estimation effort based purely on the likely cost versus the perceived value of any prospective reduction in regulatory capital.