Large exposures

Financial undertakings shall monitor and manage large exposures in accordance with Part Four of Regulation (EU) No. 575/2013  on prudential requirements for credit institutions and investment firms (CRR), cf. Article 78(c) of Act No. 161/2002 on Financial Undertakings, which deals with the management of concentration risk.

The main function of rules on large exposures is to promote risk diversification in the operations of financial undertakings and prevent the cascading effects of financial difficulties for a client or a group of connected clients. To that end, rules have been established that limit the amount of risk financial undertakings can incur towards a client or group of connected clients who are interconnected in a specified way.

Part Four of the CRR, or more specifically Articles 387-403 of the CRR, provides for large exposures. It prescribes, among other things, the definition and calculation of large exposures, restrictions on such exposures, exempt asset items, and the reporting and reporting obligations of financial undertakings.

Financial undertakings shall have sound management and accounting procedures and adequate internal control systems to identify, manage, monitor, report on and record all large exposures and changes to them, cf. Article 393 of the CRR.

An exposure to a client or group of connected clients is considered a large exposure if its value amounts to 10% or more of the Tier 1 capital, cf. Article 392 of the CRR. An exposure in this sense refers to any asset or off-balance sheet item without applying the risk weights or degrees of risk, cf. Article 389 of the CRR.

A group of connected clients in the aforementioned sense means one of the following, cf. point 39 of the Paragraph 1 of Article 4 of the CRR:

1. Two or more natural or legal persons who, unless it is shown otherwise, constitute a single risk because one of them, directly or indirectly, has control over the other or others;

2. Two or more natural or legal persons between whom there is no relationship of control as described in point (a) but who are to be regarded as constituting a single risk because they are so interconnected that, if one of them were to experience financial problems, in particular funding or repayment difficulties, the other or all of the others would also be likely to encounter funding or repayment difficulties.

Rules No. 1343/2024 on large exposures of financial undertakings (Icelandic), implement three EU Commission Delegated Regulations regarding large exposures. These are Commission Delegated Regulation (EU) No 1187/2014 for determining the overall exposure to a client or a group of connected clients in respect of transactions with underlying assets, Commission Delegated Regulation (EU) No 2023/2779, specifying the criteria for the identification of shadow banking activities, cf. Paragraph 2 of Article 394 of the CRR, and Commission Delegated Regulation (EU) No 2024/1728, specifying in which circumstances the conditions for identifying groups of connected clients are met.

The European Banking Authority (EBA) has issued guidelines on connected clients (EBA/GL/2017/15),[1]  and guidelines regarding limits on exposures to shadow banking entities which carry out banking activities outside a regulated framework (EBA/GL/2015/20).[2]

Limits on large exposures vary depending on whether the client in question is a financial undertaking or not, cf. Article 395 of the CRR.

The main principle is that a financial undertaking shall not incur an exposure, after taking into account the effect of the credit risk mitigation to a client or group of connected clients the value of which exceeds 25 % of its Tier 1 capital, cf. Paragraph 1 of Article 395 of the CRR.

Where that client is an financial undertaking or where a group of connected clients includes one or more undertakings, that value shall not exceed 25 % of the undertaking's Tier 1 capital or ISK 10 billion,[3] whichever the higher, provided that the sum of exposure values, after taking into account the effect of the credit risk mitigation to all connected clients that are not financial undertakings does not exceed 25 % of the undertaking's Tier 1 capital, cf. first subparagraph of Paragraph 1 of Article 395 of the CRR. Where the amount of ISK 10 billion is higher than 25 % of the undertaking's Tier 1 capital the value of the exposure, after taking into account the effect of credit risk mitigation, shall not exceed a reasonable limit in terms of the undertaking's Tier 1 capital, which shall be determined by the undertakings in accordance with its policies and procedures to address and control concentration risk, cf. Article 78(c) of the Act on Financial Undertakings. However, this limit shall not exceed 100 % of the undertaking's Tier 1 capital.

Paragraph 1 of Article 400 of the CRR lists the types of exposures that are exempt from the large exposures rules, in particular asset items constituting secured or unsecured claims on central governments, central banks or public sector entities and similar claims on international organisations or multilateral development banks. The Financial Supervisory Authority is authorised, pursuant to the Paragraph 2 of the same Article, to exclude, in part or in whole, specified exposures, provided that further specified conditions are met, cf. Paragraph 4 of the Article. According to Article 4 of Rules No. 789/2022 on the application of options and discretions provisions under the Financial Undertakings Act (Icelandic), the Financial Supervisory Authority has exempted covered bonds and some claims on specified regional and local governments from the rules on large exposures.

If exposures exceed 25% of the Tier 1 capital, the relative undertaking shall report the value of the exposure without delay to the Financial Supervisory Authority which may, where the circumstances warrant it, allow the undertaking a limited period of time in which to comply with the limit, in accordance with Article 396 of the CRR.

The reporting requirement if an exposure exceeds 25% of Tier 1 capital is discussed in greater detail in the EBA guidelines (EBA/GL/2021/09).[4]

[1] Guidelines on connected clients under Article 4(1)(39) of Regulation (EU) No 575/2013.

[2] Guidelines on limits on exposures to shadow banking entities which carry out banking activities outside a regulated framework under Article 395(2) of Regulation (EU) No 575/2013.

[3] According to Article 3 of the Rules on the application of the options and discretions provisions under the Financial Undertakings Act, the limit on exposures to a client that is a financial undertaking or to a group of connected clients where one or more is a financial undertaking pursuant to Paragraph 1 of Article 395 of the CRR, shall be ISK 10 billion instead of EUR 150 million.

[4] Guidelines specifying the criteria to assess the exceptional cases when institutions exceed the large exposure limits of Article 395(1) of Regulation (EU) No 575/2013 and the time and measures to return to compliance pursuant to Article 396(3) of Regulation (EU) No 575/2013.