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Effective limit setting depends on the availability of meaningful exposure measurement methodologies. In particular, banks should establish overall credit limits at the level of individual counterparties that aggregate different types of exposures in a comparable and meaningful manner.
Effective measures of PFE are essential for the establishment of meaningful limits, placing an upper bound on the overall scale of activity with, and exposure to, a given counterparty, based on a comparable measure of exposure across a bank’s various activities (both on and off-balance-sheet). Mark-to-market exposures should be monitored against initial limits on PFE.
Banks should monitor actual exposures against these initial limits and have in place clear procedures for bringing down exposure as such limits are reached. Moreover, limits should generally be binding and not driven by customer demand. A bank’s limit structure should cover the types of exposures discussed in Section IV.
Moreover, banks’ credit limits should recognise and reflect the risks associated with the near-term liquidation of derivatives positions in the event of a counterparty default. Where a bank has several transactions with a counterparty, its potential exposure to that counterparty is likely to vary significantly and discontinuously over the maturity over which it is calculated. PFEs should therefore be calculated over multiple time horizons. In the case of collateralised OTC derivatives exposures, limits should factor in the unsecured exposure in a liquidation scenario, that is, the amount that could be lost over the time it takes to rebalance positions and liquidate collateral (net of any initial margin received).
Finally, banks should consider the results of stress testing in the overall limit setting and monitoring process.
