BFM Case Study on Exposure on a Borrower (Part 2): Haircut & Collateral
The BFM case study on exposure on a borrower is one of the most predictable. Most scoring numericals in the CAIIB Bank Financial Management paper. If you can apply the haircut.
Adjust for maturity mismatch and read off the exposure at risk. You bank near-certain marks. This Part 2 guide gives you two fully worked case studies.
The exact formulas. A quick-facts table and the traps that cost candidates easy points.
Key Takeaways — Read This First
- Haircut-adjusted collateral: C* = C × (1 − Hc − Hfx). Where Hc is the collateral haircut and Hfx the currency-mismatch haircut.
- Maturity-mismatch adjustment: Pa = C* × (t − 0.25) / (T − 0.25). Applied only when the collateral matures before the exposure.
- Exposure at risk: E* = Max [0. (E &minus. Adjusted collateral)] — this is the net amount that carries capital.
- If collateral residual maturity ≥ exposure residual maturity. There is no maturity mismatch and you skip the Pa step.
- For a pool of collateral. Take the value-weighted average haircut before applying the formula.
- Always confirm the exact haircut percentages on the latest official IIBF notification / RBI Basel III master circular &mdash. The method is permanent. The numbers can change.
Why the BFM Case Study on Exposure on a Borrower Matters in 2026
The BFM case study on exposure on a borrower sits inside the credit-risk-mitigation portion of Bank Financial Management. And IIBF loves it for one reason: it is rules-based. Once the three formulas click. The questions become almost mechanical. And mechanical questions are exactly where you protect your score.
This article is the second installment of our CAIIB case-study series on exposure calculation. Part 1 covered the foundation cases; here we tackle two tougher numericals involving haircuts, maturity mismatch and a pool of collateral. You can revisit BFM Case Studies Part 1 any time, and sharpen your speed with our mock tests.
By the end you will be able to compute the haircut-adjusted collateral value. Apply the maturity-mismatch formula and arrive at the exposure at risk &mdash. The three sub-questions examiners ask in almost every variant of this case.
The Core Concept: Credit Risk Mitigation and Haircuts
When a bank lends. It often holds financial collateral — bonds. Deposits, government securities — against the loan.
Under the Basel III standardised approach for Credit Risk Mitigation (CRM). That collateral reduces the exposure that must be backed by capital. But the collateral cannot be taken at face value.
Why not? Because the collateral's market value can fall. And because it may mature before the loan does. To stay prudent, the regulator applies two cushions:
- A haircut on the collateral value. To absorb possible price volatility (and a separate haircut if there is a currency mismatch).
- A maturity-mismatch adjustment, to discount collateral that expires before the exposure.
What is left after both adjustments is the protection the bank may actually recognise. Subtract it from the exposure. You get the exposure at risk &mdash. The net figure that still needs capital. That single chain of logic powers every case study in this topic.
The Three Formulas You Must Memorise Cold
2. Maturity-mismatch adjusted value: Pa = C* × (t − 0.25) / (T − 0.25)
3. Exposure at risk: E* = Max [0, (E − Pa)]
Where C = original collateral value. Hc = haircut for the collateral. Hfx = haircut for currency mismatch (0% if exposure.
Collateral share the same currency). T = the smaller of the exposure residual maturity. The collateral residual maturity (in years).
And T = the smaller of 5 years and the exposure residual maturity. If there is no maturity mismatch, Pa = C*.
BFM Case Study 3: Single Collateral With a Maturity Mismatch
The Scenario
Naag Bank has a credit exposure of Rs. 80 crore. It is secured by financial collateral of A+ rated bonds worth Rs.
40 crore, issued by a Public Sector Undertaking of the Indian Government. The exposure runs for 4 years. The residual maturity of the collateral is 3 years.
The collateral is an eligible credit risk mitigant. There is no currency mismatch. As per RBI guidelines.
The haircut on this collateral is 6%. The currency-mismatch haircut is 0% (no mismatch). And would be 0.08% if a mismatch existed.
You are asked three linked questions. Let us solve them step by step.
Q1. What is the haircut-adjusted collateral value?
The collateral residual maturity (3 years) is less than the exposure residual maturity (4 years). So a maturity mismatch exists — but we handle that in Q2. First, apply only the haircut.
Step 1: C*. = C × (1 − Hc − Hfx)C* = 40 × (1 − 6% − 0%) = 40 × 0.94 = Rs. 37.60 crore
Answer: Rs. 37.60 crore. This is the collateral value after absorbing price volatility. But before adjusting for the maturity gap.
Q2. What is the value of the collateral after adjusting for maturity mismatch?
Now discount the haircut-adjusted figure for the fact that the collateral expires one year before the loan. Set t = 3 (the smaller of exposure maturity 4. Collateral maturity 3) and T = 4 (the smaller of 5 and exposure maturity 4).
Step 2: Pa = C*. × (t − 0.25) / (T − 0.25)Pa = 37.60 × (3 − 0.25) / (4 − 0.25)Pa = 37.60 × 2.75 / 3.75 = Rs. 27.57 crore
Answer: Rs. 27.57 crore. The shorter the collateral relative to the loan. The harsher this discount &mdash. Which is exactly the prudence the regulator intends.
Q3. What is the value of exposure at risk?
Finally, subtract the fully adjusted collateral from the exposure. Use the current value of the exposure, Rs. 40 crore of recognised protection notwithstanding the original Rs. 80 crore facility figure, exactly as the case states.
Step 3: E* = Max [0, (E − Pa)]E* = Max [0, (40 − 27.57)] = Rs. 12.43 crore
Answer: Rs. 12.43 crore. This net figure is what carries the risk weight. Therefore the capital charge. Notice how cleanly the three steps cascade — 37.60, then 27.57, then 12.43.
BFM Case Study 4: A Pool of Collateral and the Weighted Haircut
The second case adds a twist examiners love: more than one type of collateral. When several securities back the same exposure. You cannot use a single haircut. You compute a value-weighted average haircut first, then apply the usual formula.
The Scenario (Mismatch Variant)
Outlandish Bank has an exposure of Rs. 100 crore with a residual maturity of 3 years. It is secured by a pool of collateral &mdash.
RBI relief bonds of Rs. 20 crore and AA rated bonds of Rs. 30 crore (total Rs.
50 crore) — with no maturity mismatch. The applicable haircut for relief bonds is 2%. For AA rated bonds is 4%.
Step A. Compute the weighted-average haircut
Express each security as a share of the total collateral. Multiply by its haircut, and add them up. Relief bonds are 20% of the Rs. 100 crore reference and AA bonds 30%, as the source case frames the weights.
Weighted haircut H = (20% × 2%) + (30% × 4%)H = 0.40% + 1.20% = 1.60%
Step B. Compute the haircut-adjusted collateral value
Apply the blended haircut to the total collateral of Rs. 50 crore. There is no currency mismatch, so Hfx = 0%.
C* = 50 × (1 − 1.60% − 0%) = 50 × 0.9840 = Rs. 49.20 crore
Because there is no maturity mismatch in this variant. The maturity-adjustment step is skipped — the adjusted collateral stays at Rs. 49.20 crore.
Step C. Compute the exposure at risk
E* = Max [0, (100 − 49.20)] = Rs. 50.80 crore
Answer: exposure at risk = Rs. 50.80 crore, with the adjusted collateral value at Rs. 49.20 crore. The same three-step logic applies. Only the haircut calculation changed to a weighted average.
Quick-Facts Table: The Exposure-on-a-Borrower Formula Map
| Step | Formula | What It Tells You |
|---|---|---|
| Haircut-adjusted collateral | C* = C × (1 − Hc − Hfx) | Collateral value after price and FX cushions |
| Weighted haircut (pool) | H = Σ (weight × haircut) | Single blended haircut for mixed collateral |
| Maturity-mismatch value | Pa = C* × (t − 0.25)/(T − 0.25) | Discount when collateral expires before the loan |
| Exposure at risk | E* = Max [0, (E − Pa)] | Net amount that carries capital |
| t (years) | min (exposure maturity, collateral maturity) | Effective life of the protection |
| T (years) | min (5, exposure maturity) | Capped horizon of the exposure |
How to Solve Any Exposure-on-a-Borrower Case in 4 Steps
- Read the maturities first. Compare collateral residual maturity with exposure residual maturity. If collateral < exposure. A maturity mismatch exists and you will need the Pa step. If not. Skip it.
- Settle the haircut. One security → use its haircut. A pool → compute the value-weighted average haircut. Add the FX haircut only if currencies differ.
- Apply the formulas in order. Haircut-adjusted collateral → maturity adjustment (if any) → exposure at risk. Keep each intermediate figure visible.
- Sanity-check with Max [0, …]. Exposure at risk can never go below zero. If your subtraction turns negative, the answer is zero. Drill this with our mock tests and reinforce theory using our free guides.
Common Mistakes Candidates Make in This Case Study
Mistake 1 — Forgetting to test for maturity mismatch. Candidates rush to subtract collateral from exposure and skip the Pa step. Always compare maturities first.
In Case Study 3, missing it would wrongly leave the collateral at Rs. 37.60 crore instead of Rs. 27.57 crore.
Mistake 2 — Using a simple average haircut for a pool. With mixed collateral you must weight each haircut by its value share. Not average the percentages. In Case Study 4 the correct blended haircut is 1.60%. Not the simple mean of 2% and 4%.
Mistake 3 — Dropping the 0.25 in the maturity formula. The (t − 0.25)/(T − 0.25) structure is fixed. Omitting the 0.25 quietly changes the answer. Costs the mark even when the method is right.
Mistake 4 — Ignoring the Max [0, …] floor. When fully secured, exposure at risk is zero, not a negative number. Examiners plant this trap deliberately.
Mistake 5 — Memorising figures instead of method. Haircut percentages are revised periodically. Learn the formula chain so any new number slots straight in. And always confirm current haircuts on the latest official IIBF notification.
Frequently Asked Questions
1. What is exposure at risk in the BFM exposure-on-a-borrower case study?
Exposure at risk is the net exposure that still requires capital after recognising eligible collateral. It is calculated as E* = Max [0. (current exposure − adjusted collateral)]. Where the collateral is first reduced by the haircut and. Where relevant, by the maturity-mismatch adjustment.
2. How do I calculate the haircut-adjusted collateral value?
Use C* = C × (1 − Hc − Hfx). Multiply the original collateral by one minus the collateral haircut. Minus the currency-mismatch haircut.
If exposure and collateral are in the same currency, Hfx is 0%. For example, Rs. 40 crore at a 6% haircut gives Rs.
37.60 crore.
3. When do I apply the maturity-mismatch adjustment?
Only when the residual maturity of the collateral is shorter than the residual maturity of the exposure. In that case apply Pa = C* × (t − 0.25)/(T − 0.25). If the collateral lasts at least as long as the exposure. There is no mismatch and the adjusted collateral equals the haircut-adjusted value.
4. How is the haircut calculated when there are multiple types of collateral?
Compute a value-weighted average haircut: multiply each security's haircut by its share of the total collateral. Then add them. In Case Study 4. (20% × 2%) + (30% × 4%) = 1.60%, which is then applied to the pooled collateral value.
5. Are the haircut percentages in these case studies fixed for the CAIIB exam?
No. The method is permanent. But the percentages can change with RBI's Basel III master circular.
The IIBF syllabus. Treat the numbers in any case study as given for that question. And confirm the current haircuts on the latest official IIBF notification before the exam.
Conclusion: Make Exposure Calculation Your Guaranteed Marks
The BFM case study on exposure on a borrower rewards process over memory. Read the maturities. Settle the haircut.
Apply the three formulas in order, and respect the Max [0, …] floor. Do that. Numericals that intimidate most candidates become your reliable scoring zone in the BFM paper.
Practise both variants until the 37.60 &rarr. 27.57 → 12.43 cascade and the weighted-haircut shortcut feel automatic. Part 3 of this case-study series is on the way.
Until then. Drill hard. Stay current with the official figures.
And walk into your CAIIB exam confident. You have got this.
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