Large Exposure Limit

A Large Exposure Limit is a Basel III rule capping how much of its capital a bank may risk on any single counterparty, or group of connected counterparties, so that the failure of one borrower or trading partner cannot by itself threaten the bank's solvency. The rule treats concentration itself as a distinct risk, separate from the ordinary credit risk of whether any given loan will be repaid.

This specific single-counterparty regime, formalized by the Basel Committee on Banking Supervision (BCBS) as part of its post-2008 reforms, is distinct from the broader concept covered under Exposure Limit, which applies more generally across risk management. The Basel large exposure framework specifically targets single-name and connected-counterparty concentration within banks' Regulatory Capital framework, and interacts closely with how banks calculate Risk-Weighted Assets (RWA) for the exposures involved.

Imagine a small investor who puts their entire life savings into a single stock because they are confident it will do well. Even a very good company can collapse unexpectedly, and a portfolio with no diversification turns one bad surprise into a total wipeout. Banks face the same temptation on a much bigger scale: lending heavily to one large, apparently reliable borrower can look profitable and safe, right up until that borrower runs into trouble. A large exposure limit is the rule that stops a bank from betting too much of its own safety net on any single name, no matter how creditworthy that name appears today.

The rule does not ban big relationships with big clients; it simply puts a ceiling on how large any single relationship can grow relative to the bank's own capital cushion, so one default cannot cause a chain reaction.

The limit is expressed as a percentage of a bank's eligible capital:

• $\text{Exposure to Counterparty}$ is the bank's total measured exposure to a single counterparty or connected group, after allowed credit risk mitigation such as eligible collateral and guarantees.
• $\text{Tier 1 Capital}$ is the bank's core capital base as defined under its capital adequacy rules.
• $\text{Large Exposure Limit}$ is the maximum percentage of Tier 1 capital regulators permit for exposure to any single counterparty, with a stricter sub-limit typically applied between global systemically important banks.

If a bank has $50 billion of Tier 1 capital and a regulatory large exposure limit of 25%, the maximum permitted exposure to any one counterparty or connected group is $0.25 \times 50 = 12.5$ billion dollars. A bank approaching that ceiling with a specific client must either stop extending further credit to that name, hedge the exposure, or seek additional capital headroom.

The rule aggregates exposures across "connected" counterparties, meaning entities under common control or with such close economic ties that the failure of one would likely trigger the failure of the other, such as a parent company and its subsidiaries, or two firms heavily reliant on each other's cash flow. This connected-counterparty concept prevents banks from circumventing the limit by lending to several legally separate entities that are, in substance, one credit risk.

Concentration at a single large bank can transmit into broader systemic risk if that counterparty is itself large enough, or interconnected enough, that its distress ripples through other institutions exposed to the same name, which is why interbank exposures and exposures to large Central Counterparty (CCP) entities receive particular regulatory attention within the large exposure framework.

The framework measures exposure using defined methodologies that may not fully capture every form of indirect risk, such as exposure through complex derivatives structures or correlated collateral, meaning a bank can be technically compliant while still carrying meaningful concentration risk that the formula underweights. The connected-counterparty test also relies on judgment about what constitutes sufficiently close economic ties, leaving room for differing interpretations across supervisors.

Large exposure calculations extend beyond simple loans to cover OTC Derivatives positions, guarantees and trade finance instruments, each measured using its own exposure methodology before being tested against the limit. A bank with heavy derivatives dealing to one large corporate or financial counterparty must track both the current mark-to-market exposure and the potential future exposure that counterparty risk could create if markets move sharply, since both components count toward the same single-name ceiling. This is one reason large dealers spread similar trades across multiple counterparties rather than concentrating them with one name, even when a single counterparty would otherwise be the most convenient or cheapest to deal with.

• Basel Committee on Banking Supervision
• Bank for International Settlements