In a bid to limit systemic risk, global banking regulators are setting limits on the size of large banks’ exposures to other firms.

The Basel Committee on Banking Supervision announced a revised standard for measuring and controlling so-called large exposures, which are designed to limit the losses a bank could suffer due to the sudden failure of an individual counterparty, or a group of connected counterparties, and to help ensure the bank itself survives. Imposing large exposure limits, the Basel Committee says, can directly contribute towards the reduction of systemwide contagion risk.

The large exposure standard published today sets a general limit of 25% of a bank’s Tier 1 capital that applies to all of a bank’s exposures to a single counterparty, and groups of connected firms that are interdependent and likely to fail simultaneously. A tighter limit of 15% will apply to exposures between banks that have been designated as global systemically important banks (GSIBs). The limits are scheduled to take effect starting in January 2019.

The Basel Committee notes that one of the key lessons from the financial crisis “was that banks did not always consistently measure, aggregate and control exposures to single counterparties or to groups of connected counterparties across their books and operations.” And, it says that throughout history there are examples of banks failing due to concentrated exposures to individual counterparties. Large exposure regulation has been developed to limit that risk.

Indeed, back in 1991 the Basel Committee developed a standard in this area, however it notes that the financial system has changed dramatically since then. And, while many jurisdictions modelled their national rules after the original standard, it says that “there have been inconsistent results across jurisdictions due to differences in measures of exposure, measures of capital and numerical limits.” The revised framework aims to help ensure a common minimum standard for measuring, aggregating and controlling single name concentration risk across jurisdictions.

Additionally, the tougher limit for systemically important banks aims to address the another lesson from the financial crisis, which is that “material losses in one systemically important financial institution can trigger concerns about the solvency of other SIFIs, with potentially catastrophic consequences for global financial stability.”

The Basel Committee says that the framework is also seen as a useful tool to help strengthen the oversight and regulation of the shadow banking system in relation to large exposures. It says that it will also review whether to set a limit for exposures to central counterparties related to clearing activities, which are currently exempted. It will also review the impact of the large exposures framework on monetary policy implementation.