Large exposures standard – Executive Summary

In 2014, the Basel Committee on Banking Supervision (BCBS) issued the large exposures (LEX) standard, which seeks to limit the loss that internationally active banks can face in the event of a sudden counterparty failure. The framework requires banks to limit the size of their exposures to a single counterparty or group of connected counterparties in relation to their capital. The standard came into force on 1 January 2019.

Objectives of the LEX standard

The LEX standard is part of the Basel III reform package. Since the Basel III risk-based capital standard implicitly assumes that banks hold fully diversified portfolios, it does not address concentration risk, which arises when a bank is overly exposed to a single counterparty or connected groups. The LEX standard complements this requirement by explicitly mitigating the concentration risk of individual banks (microprudential objective). Moreover, it also supports efforts to manage the risk of systemic contagion by setting stricter limits for exposures of global systemically important banks (G-SIBs) to other G-SIBs (macroprudential objective).

The large exposure limit

A large exposure is defined as the sum of all exposure values of a bank to a single counterparty or to a group of connected counterparties that are equal to or above 10% of its Tier 1 capital.

The minimum requirements, that is, the "large exposure limits" of the LEX standard, are as follows:

• The sum of all exposure values of a bank to a single counterparty or to a group of connected counterparties must not be higher than 25% of the bank's Tier 1 capital, at all times.
• G-SIBs face a stricter limit of 15% of the bank's Tier 1 capital on exposures to other G-SIBs.

If the limits are breached, immediate reporting to the supervisor and rapid rectification are required.

Level of application and scope of counterparties

The LEX standard is applicable at every tier within a banking group. A bank must consider all exposures to third parties across the relevant regulatory consolidation group and compare the aggregate of those exposures with the group's Tier 1 capital.

Some counterparties are exempted from the LEX standard:

• sovereigns and entities connected with sovereigns, including their central banks;
• exposures to qualifying central counterparties related to clearing activities; and
• intraday interbank exposures (to avoid disrupting payment and settlement processes).

Banks must consider exposures even when there is a structure (eg a fund or securitisation) between the bank and the exposures.

Connected counterparties

When a number of counterparties have specific relationships and dependencies such that a failure of one of the counterparties could lead to cascading failures of the rest, the large exposure limit applies to the cumulative exposures to the group of connected counterparties.

Under the LEX standard, two parties are connected if at least one of the following criteria is satisfied:

• a control relationship, where one of the counterparties has direct or indirect control over the other;
• economic interdependence, where, if one of the counterparties were to experience financial problems, such as funding or repayment difficulties, the other would also encounter financial difficulties.

Exposure measurement

All exposures as defined under the Basel III risk-based capital standard are subject to the LEX standard. These include on- and off-balance sheet exposures in both the banking and trading books and instruments with counterparty credit risk under the risk-based capital framework. To reduce complexity, the LEX standard uses, where practicable, the same value of exposures as the risk-based capital framework. In general, the exposure values are based on the accounting value of the exposure.

In the banking book, on-balance sheet exposure values are based on accounting values. Off-balance sheet exposures are converted to credit exposure equivalents using credit conversion factors as defined in the standardised approach for credit risk. In the trading book, exposure values are measured consistent with the market risk framework.

Eligible credit risk mitigation

Credit risk mitigation techniques that meet the minimum requirements and eligibility criteria as defined under the standardised approach for credit risk can also be used to reduce exposure values for large exposures purposes. For example, for both unfunded credit protection (that is, guarantees and credit derivatives) and financial collateral, a bank must reduce the exposure value by the value of the protected or collateralised portion of the exposure, subject to applicable haircuts.

Regulatory reporting

A bank must report to the supervisory authority:

• all exposures with values equal to or above 10% of its Tier 1 capital;
• all other exposures with values, measured without considering credit risk mitigation, equal to or above 10% of its Tier 1 capital;
• all exempted exposures with values equal to or above 10% of its Tier 1 capital; and
• the 20 largest exposures to counterparties that fall within the scope of application, irrespective of the values of these exposures relative to its Tier 1 capital.

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This Executive Summary and related tutorials are also available in FSI Connect, the online learning tool of the Bank for International Settlements.