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Home Basel Committee Summary of Basel Committee’s Proposed Framework for Measuring and Controlling Large Exposures

Summary of Basel Committee’s Proposed Framework for Measuring and Controlling Large Exposures

The Basel Committee has proposed a framework for measuring, reporting and limiting a bank’s exposures to single counterparties and groups of connected counterparties.  The proposed large exposures framework, which borrows a number of concepts from the Basel capital framework, is intended to ensure greater international consistency in regulatory and supervisory approaches to large exposures and to act as a backstop to risk-based capital requirements.  The Basel Committee expects national supervisors to implement the large exposures framework by January 1, 2019.

Comments on the proposed framework are due June 28, 2013.  Below is a high-level overview of the proposed large exposures framework.

Overview of the Basel Committee’s Proposed Large Exposures Framework

Scope of Application:  The proposed large exposures framework would apply to all internationally active banks and would apply at the same levels within an organization as the risk-based capital requirements.  For a banking group, this means the framework would apply both at the consolidated group-wide level and at the level of individual bank subsidiaries.

Size of Large Exposures Limit:  The Basel Committee proposes to limit a bank’s large exposures to either 25% of its Common Equity Tier 1 capital or 25% of its Tier 1 capital, each as defined in Basel III.  The Basel Committee is still considering which measure to use and will take into account the results of a quantitative impact study.

Stricter Exposure Limit for G-SIBs:  The Basel Committee believes the large exposure limit that would apply to exposures between global systemically important banks (G-SIBs) should be between 10% and 15% of the G-SIB’s Common Equity Tier 1 or Tier 1 capital.  The Basel Committee also encourages jurisdictions to consider applying stricter limits to exposures to domestic systemically important banks (D-SIBs) and to exposures of smaller banks to G-SIBs.

Group of Connected Counterparties:  Under the proposed framework, a bank must treat a group of connected counterparties as a single counterparty.  Two or more natural or legal persons shall be deemed a group of connected counterparties if there is (1) a control relationship, i.e., one of them directly or indirectly, has control over the other(s) or (2) economic interdependence, i.e., if one of them were to experience financial problems, in particular funding or repayment difficulties, the other(s) would as a result likely also encounter funding or repayment difficulties.

Transactions Covered:  Generally, any exposure attracting a capital charge under the Basel risk-based capital framework would be captured under the proposed large exposures framework.  This covers a broad range of transactions, including: commercial and retail loans, debt and equity securities, guarantees and letters of credit, derivatives, securities financing transactions, investment funds equity exposures, securitizations, and certain trading book positions.

Measuring Exposures – Internal Models Not Permitted:  Generally, the proposed rules for determining exposure amounts and for recognizing credit risk mitigants closely follow the Basel capital framework.  However, the Basel Committee is proposing to not permit banks to use internal models to calculate their large exposures because such an approach would be inconsistent with the large exposure framework’s purpose as a simple, internationally harmonized backstop to risk-based capital requirements.

Sovereign Exposures Excluded:  Exposures to sovereigns are not part of the proposed large exposures framework because the Basel Committee believes that the appropriate treatment of concentrated sovereign exposures will need to be addressed as part of a broader review of the treatment of sovereign risk within the regulatory framework.  However, exposures to non-central government public sector entities and multilateral development banks would be subject to the proposed framework.

Exposures to Central Counterparties:  The Basel Committee seeks comments on two approaches to exposures to central counterparties (CCPs).

  • The first approach would be to limit banks’ exposures to qualifying CCPs (QCCPs), as defined in the Basel capital framework, although the limit may need to be higher than the general 25% limit to take into account the fact that banks are or will be required to submit certain transactions for central clearing.
  • The second approach would not impose a “hard” limit on a bank’s exposures to QCCPs, but would still require the bank to report all large exposures to QCCPs to its supervisor, which would monitor potential concentration risks and take appropriate supervisory actions where needed.
  • Under either approach, a bank would calculate its exposure to a QCCP in the form of trade exposures, non-bankruptcy remote initial margin posted to the QCCP, default fund contributions and equity stakes using methods provided in the risk-bank capital framework.  Moreover, where a transaction between a client and a clearing member is treated as one with a QCCP under the applicable solvency regime, the client may also treat its exposure as one with the QCCP (and not with the clearing member) under the proposed large exposures framework.  A bank’s exposures to non-QCCPs would be treated as bilateral transactions under the framework.

Large Exposures to Funds, Securitization Structures and Collective Investment Undertakings:  With respect to exposures to funds, securitization structures and collective investment undertakings, the Basel Committee proposes to require banks to apply a look-through approach to underlying assets, where feasible, and to assess possible additional risks that do not relate to the structure’s underlying assets, but rather to the structure’s specific features and to any third parties linked to the structure.  Where additional risks are identified, a new exposure must generally be recognized for large exposure purposes.

Interbank Exposures:  The large exposures limit would apply to interbank exposures in the same way as any other exposures to third parties.  However, the Basel Committee is seeking comments on whether there should be exemptions for (1) intraday interbank exposures and (2) certain overnight interbank exposures.

Large Exposures Reporting:  In addition to the large exposures limit, the Basel Committee proposes that banks should report to their supervisor all their large exposures or, if the number of large exposures is less than 20, their largest 20 exposures irrespective of size.  The Basel Committee proposes to set the threshold defining a large exposure at 5% of the bank’s Common Equity Tier 1 or Tier 1 capital, each as defined in Basel III.  Large exposures to counterparties to which the proposed large exposures limit does not apply (e.g., sovereign exposures) should also be reported.

Comparison with U.S. Dodd-Frank Proposals and EU CRD IV:  In the United States, the Federal Reserve has proposed single counterparty credit limits (SCCLs) for large U.S. bank holding companies, large foreign banking organizations and nonbank financial companies that are designated as systemically important by the Financial Stability Oversight Council.  There are significant differences among the Basel Committee’s proposed large exposures framework, the Federal Reserve’s proposed SCCLs and the EU large exposures regime in CRD IV.

Materials:   

Basel Committee, Supervisory Framework for Measuring and Controlling Large Exposures (Consultative Document) (Mar. 25, 2013) available here: http://www.bis.org/publ/bcbs246.pdf

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