Banks lack consensus on managing funding valuation adjustments

Key facts

• FVA arises when a bank hedges an unsecured trade with a riskless counterparty.
• FVA represents the expected value of the funding cost.
• Banks must decide whether to pass FVA costs to counterparties or absorb them.

An ongoing industry debate centers on whether banks should include funding valuation adjustments (FVA) in pricing, thereby passing the costs to counterparties, or absorb these costs internally. FVA arises when a bank hedges an unsecured trade with a riskless counterparty, leading to borrowing costs that are expected to be borne by the bank. To mitigate these costs, banks aim to reduce borrowing rates and select trades that minimize funding expenses. A profitability calculator is essential to compare trade profit and loss against FVA and other incurred costs before executing a trade.