What is Current Exposure Method of credit exposure?

The Current exposure method (CEM) is a measurement of the replacement cost within a derivative contract in the case of a counterparty default. Here, the credit equivalent amount of a market related off-balance sheet transaction calculated using the current exposure method which will be the sum of current credit exposure and potential future credit exposure of transactions like swaps, forwards, options, and other contracts.

The Current Exposure Method requires periodical calculation of the current credit exposure by marking these contracts to market, thus capturing the current credit exposure. Whereas potential future credit exposure is determined by multiplying the notional principal amount of each of these contracts irrespective of whether the contract has a zero, positive or negative mark-to-market value by the relevant add-on factor indicated below according to the nature and residual maturity of the instrument

From April 1, 2018 RBI directed banks to implement the ‘Standardised Approach for Counterparty Credit Risk (SA-CCR)’ in place of Current Exposure Method (CEM), used by banks.