There are two methods for adjusting capital requirements for collateral under Basel II. The simple approach and the comprehensive approach. Banks can choose which approach they wish to use in the banking book. In the trading book they must use the comprehensive approach.
Under the simple approach, risk weights of the counterparty is replaced by the risk weight of the collateral for the part that is covered by the collateral. For any exposure not covered by the collateral, the risk weight of the counterparty is used.
Under the comprehensive approach, the bank adjusts the capital requirements upwards to allow for an increase in the credit risk. The bank also adjusts the value of the collateral downward to allow for a decrease in value.
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