United States: Federal Reserve Board Proposes New Single-Counterparty Credit Exposure Limits For Large Banking Organizations

Last Updated: April 13 2016
Article by Lisa M. Ledbetter and Courtney Lyons Snyder

A principal tenet of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 20101 ("Dodd-Frank Act") was creation of a comprehensive approach for mitigating threats to the financial stability of the United States ("U.S.") posed by systemically important financial institutions ("SIFI").

The Dodd-Frank Act mandates a comprehensive set of regulatory reforms designed to address threats to U.S. financial stability. These reforms cover enhanced prudential regulation of large bank holding companies ("BHC") and nonbank companies that are designated by the Financial Stability Oversight Council ("FSOC") for additional oversight by the Board; enhanced regulation of over-the-counter derivatives and other core financial markets and financial market utilities; and orderly liquidation authority for financial companies, among other important reforms.

While the federal financial regulators have adopted key macroprudential rules to fulfill the requirements of the Dodd-Frank Act, several significant rules are still under development. Chief among these is the adoption of a rule setting credit exposure limits for large domestic and foreign banking organizations. The Board originally proposed rules on single-counterparty credit exposure limits in 2011 for domestic BHCs and in 2012 for FBO and U.S. IHCs as part of a proposal to establish a set of enhanced prudential standards, but the Board did not adopt these proposed rules (collectively, the "Original Proposals") in the final rule on enhanced prudential standards.2

On March 4, 2016, the Board invited public comments on a new proposal (the "New Proposal"),3 pursuant to Section 165(e) of the Dodd-Frank Act ("Section 165(e)"),4 that would apply increasingly stringent single-counterparty credit exposure limits to large domestic and foreign banking organizations as their systemic significance increases, in accordance with the following framework:

  • First Category: A domestic BHC, FBO, and U.S. IHC with total consolidated assets of $50 billion or more5 would be prohibited from having aggregate net credit exposure to a single counterparty in excess of 25 percent of the company's total regulatory capital plus allowance for loan and lease losses ("ALLL") not included in Tier 2 capital. This is the limit set by Section 165(e).
  • Second Category: A domestic BHC, FBO, and U.S. IHC with total consolidated assets of $250 billion or more, or $10 billion or more in on-balance-sheet foreign exposures, would be prohibited from having aggregate net credit exposure to a single counterparty in excess of 25 percent of the company's Tier 1 capital.
  • Third Category: A domestic BHC that is a global systemically important banking organization ("G-SIB"), any U.S. IHC with total consolidated assets of $500 billion or more, and any FBO with total worldwide consolidated assets of $500 billion or more—defined collectively as a "major covered company"—would be prohibited from having aggregate net credit exposure to a "major counterparty" in excess of 15 percent of the major covered company's Tier 1 capital. A "major counterparty" would include a major covered company, any other FBO that has the characteristics of a G-SIB, and any nonbank financial company designated by the FSOC for additional oversight by the Board.

The New Proposal is designed to "enhance the resiliency and stability" of the U.S. financial system by setting a "bright line on total credit exposures between one large [BHC] and another large bank or major counterparty."6 Overall, the Board intends the New Proposal to mitigate risks to financial stability that can arise from the interconnectivity among major financial institutions because "trouble at one big bank will bring down other big banks."7 In her opening statement on the Board's consideration of the New Proposal, Board Chair Yellen explained:

In the financial crisis, we learned that the largest and most complex banks and financial institutions lent or promised to pay large amounts to other institutions that were also very large and complex. These credit extensions and promises did not eliminate risk, and in many cases they magnified it.8

The limits on single-counterparty credit exposures in the New Proposal are thus intended to be "tailored to the systemic footprint of covered companies"9 by imposing increasingly stringent limits as the systemic significance of a covered company increases. The New Proposal would not apply to credit exposures of any nonbank SIFI that the FSOC has designated for additional oversight by the Board; however, these nonbank SIFIs are considered counterparties for purposes of measuring credit exposure limits for major covered companies, the largest and most complex financial firms.10

The Board has invited public comments on all aspects of the New Proposal through June 3, 2016, and has raised specific questions and alternatives for comment throughout the New Proposal.

This White Paper describes key features of the New Proposal, highlights important changes made to the New Proposal, and explains differences between the New Proposal and the Basel Committee on Banking Supervision's ("Basel Committee") large exposures framework for internationally active banks ("Large Exposures Framework") issued in 2014.11

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1 Public Law 111-203, 124 Stat. 1376 (2010).

2 77 Fed. Reg. 594 (Jan. 5, 2012); 77 Fed. Reg. 76628 (Dec. 28, 2012) (collectively "Original Proposals"); 79 Fed. Reg. 17240 (March 27, 2014) (codified at 12 C.F.R. part 252).

3 Single-Counterparty Credit Limits for Large Banking Organizations, 81 Fed. Reg. 14327 (proposed March 16, 2016) (to be codified at 12 C.F.R. part 252) ("New Proposal").

4 12 U.S.C. § 5365(e).

5 The proposed limits would apply to FBOs with $50 billion or more in total worldwide consolidated assets. New Proposal, 81 Fed. Reg. 14345.

6 Opening Statement on the Proposed Rule Establishing Single-Counterparty Credit Limits for Large Banking Organizations by Board Chair Janet Yellen (March 4, 2016).

7 Id.

8 Id.

9 Memorandum to the Board of Governors of the Federal Reserve System from Governor Tarullo on Proposed rules to implement single-counterparty credit limits in section 165(e) of the Dodd-Frank Act (February 26, 2016) ("Staff Memo").

10 Specifically, nonbank SIFIs are included as counterparties for purposes of the 15 percent limit that applies to major covered companies. See New Proposal, 81 Fed. Reg. 14330.

11 Basel Committee on Banking Supervision, Bank for International Settlements, Standards: supervisory framework for measuring and controlling large exposures (April 2014).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Lisa M. Ledbetter
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