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Board of Governors of the Federal Reserve System
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Calibrating the Single-Counterparty Credit Limit between Systemically Important Financial Institutions

Summary and Concluding Remarks

In an effort to address the risk to financial stability posed by large financial companies, section 165(e) of the Dodd-Frank Act directs the Board to establish single-counterparty credit limits for large bank holding companies and foreign banking organizations. This section directs the Board to prescribe regulations that prohibit covered companies from having credit exposure to any unaffiliated company that exceeds 25 percent of the capital of the covered company or such lower amount as the Board may determine to be necessary to mitigate risks to U.S. financial stability.

The default of multiple SIFIs would clearly present considerable threats to financial stability. Moreover, the risk of multiple SIFI defaults increases when SIFIs extend credit to each other, because the range of activities in which SIFIs are engaged as well as their counterparties and funding sources all display a significant degree of commonality. As a result of the relatively high levels of correlation among SIFIs, it is appropriate to require that credit extensions between SIFIs be subject to a more stringent single-counterparty credit limit. It should also be noted that the existence of more stringent single-counterparty credit limits on inter-SIFI credit exposures does not necessarily limit the ability of a SIFI to transact with other SIFIs in the aggregate. SIFIs are free to generate exposures with individual other counterparties that are below the single-counterparty credit limit, and any exposures that would breach the limit may be reallocated to other SIFIs that are under the exposure limit. Accordingly, the presence of tighter inter-SIFI limits does not prevent SIFIs from engaging in conduct that is necessary to provide credit services to the economy.

A credit risk model is employed to provide quantitative guidance on the range of inter-SIFI credit limits that are appropriate in light of the considerations discussed above. The results indicate that the proposed credit limit of 15 percent is appropriate and consistent with the range of outcomes presented in the model. Since the model does not explicitly reflect the greater harm to financial stability that would result from multiple SIFI defaults, the appropriate level of the inter-SIFI credit limit may be somewhat more stringent than the levels presented in this analysis. Moreover, the specific quantitative model that has been employed is relatively simple and abstracts from a number of considerations that could be considered in the analysis. But, overall, a number of qualitative and quantitative factors indicate that the proposed inter-SIFI limit of 15 percent is appropriate and in keeping with the Dodd-Frank Act's requirement to prescribe more stringent limits when required to mitigate financial stability risks

Last update: March 21, 2016

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