Leveraged Lending

Setting Concentration Limits

Leveraged finance and other loan portfolios with above-average default probabilities tend to behave similarly during an economic or sectoral downturn. Consequently, banks should take steps to avoid undue concentrations by setting limits consistent with their appetite for risk and their financial capacity. Banks should ensure that they monitor and control as separate risk concentrations those loan segments most vulnerable to default. For example, banks should consider identifying concentrations by:

The degree of leverage in the transaction.

The bank’s internal risk grade.

Industry or other factors that the bank determines are correlated with an above-average default probability.

In addition, sub-limits may be appropriate by collateral type, loan purpose, secondary source of repayment, and sponsor relationships. Banks should also establish limits for the aggregate number of policy exceptions.

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