Legal Lending Limit
Candlefocus EditorThe legal limit for national banks is 15% of the bank’s capital. This calculation is taken from the institution’s total capital divided by the total amount of credit extended. This takes into account the risk that the institution would absorb if the client were to default on the loan agreement. Given this, the legal limit for national banks helps regulate the amount of risk that institutions are able to take and makes sure that the majority of credit extended does not go to one single customer.
However, the legal lending limit can be increased if the loan is secured with readily marketable securities, such as stocks and bonds. If a loan agreement is secured with this asset, the bank or thrift can extend up to 25% of its total capital to that customer. Some loans, such as those secured by U.S. obligations and other forms of commercial paper, are exempt from the legal lending limit. Likewise, state-chartered banks may have their own legal lending limits, though they are often similar to the OCC standard.
The legal lending limit is an important risk management tool that is essential for any banking institution. Not only does it help institutions to control their debt exposure, but it also serves as a regulator for the risk taken with issuing certain types of loans. This, in turn, helps to promote financial stability and maintain public trust in financial and banking institutions.