The need for banks to measure and limit the size of large exposures in relation to their capital has long been recognised by the Basel Committee on Banking Supervision. As such, large exposures regulation has been developed as a tool for limiting the maximum loss a bank could face in the event of a sudden counterparty failure to a level that does not endanger the bank’s solvency.
What is a Large Exposure?
The European Capital Requirements Regulation (CRR) requires that firms report every large exposure, where large exposures are defined as:
‘exposures to clients or groups of connected client where its value is equal or exceeds 10 % of the eligible capital of the institution’.
Additionally, the implementation of CRR requires the reporting of certain largest exposures and that firms report information related to exposures to clients and groups of connected clients not considered large exposures in accordance with the CRR, but which have an exposure value larger than or equal to €300 million.
Large Exposure Limit
The overall large exposure limit of a firm to a single counterparty or to a group of connected counterparties must not be higher than 25% of the firm’s available eligible capital base at all times. However, this figure is set lower (at 15%) for a Global Systemically Important Bank’s exposure to another of its kind.
If at any point a firm exceeds the Large Exposure limit, the firm must immediately inform the regulator and rapidly rectify this.
What is the aim of a Large Exposures Regime?
The core aim of a large exposures regime is to act as an overlay "to prevent a firm from incurring disproportionately large losses as a result of the failure of an individual client or group of connected clients due to the occurrence of unforeseen events".