What Is the Legal Lending Limit?

 

A legal lending is the maximum amount of money a bank can lend to a single borrower. Every financial institution in the U.S. has a legal lending limit that is overseen by the Federal Deposit Insurance Corp. (FDIC) and the Office of the Comptroller of the Currency (OCC). 

The current code on legal lending limits states that a financial institution cannot lend more than 15% of its capital and surplus.1 However, this can vary somewhat, depending on whether the bank operates at a state or federal level and whether a borrower uses collateral to secure the loan. 

Definition and Examples of the Legal Lending Limit 

The lending limit is the highest amount of money a bank or financial institution can lend to an individual borrower. In the U.S., the legal lending limit is outlined in Part 32.3 of the U.S. Code (USC). The FDIC and OCC are responsible for managing the legal lending limit and guiding banks on how to enforce it.

The legal lending limit cannot exceed 15% of a bank’s capital and surplus for a single borrower. If the borrower is taking out a secured loan, the bank can lend up to 25% of its capital and surplus.1

A bank’s capital is defined as the difference between its assets and its liabilities. In comparison, surplus includes things like profits and loss reserves. 

How Does the Legal Lending Limit Work? 

Lending limits exist to promote the safety of putting your money in the national banking system. These limits also prevent banks from offering excessive loan amounts to one individual, which supports the diversification of loans.

As mentioned, the standard lending limit dictates that a bank can’t lend a single borrower more than 15% of its available capital and surplus. If the borrower secures the loan with collateral, banks can lend them up to a quarter of their capital and surplus.

However, certain loans are not subject to legal lending limits, including those:1

• To other financial institutions
• Arising from the discount of commercial or business paper
• Affiliated with a federal agency 
• Issued due to U.S. obligations
• To the Student Loan Marketing Association (SLMA), also known as Sallie Mae
• To leasing companies and industrial development agencies

Types of Capital  

Banks and other financial institutions must maintain a certain amount of money in their reserves as capital and surplus. In the U.S., these minimum requirements are set and regulated by federal laws. A bank’s capital is the difference between its assets and liabilities and represents its total net worth. This capital represents a bank’s ability to absorb losses if the bank liquidates. 

Bank capital is classified into three separate levels: tier 1, tier 2, and tier 3.

Tier 1 

Tier 1 capital is a bank’s core reserves and primary source of funding. It is the assets a bank holds to continue providing for the needs of its customers. Tier 1 capital includes common stock, retained earnings, and preferred stock.

Tier 2 

Tier 2 capital is the bank’s supplementary capital and includes things like revaluation reserves, qualifying preferred stock, and subordinated debt. 

Tier 3 

Tier 3 capital is the supplementary capital banks hold to support their minimum capital requirements. It includes a greater variety of short-term debt than either of the first two tiers. 

Key Takeaways

• The legal lending limit is the maximum amount of money a financial institution can lend to a single borrower.
• The lending limit is set by the U.S. Code and overseen by the FDIC and the OCC.
• For a single borrower, the legal lending limit cannot exceed 15% of the bank’s capital and surplus.
• A bank’s capital is the difference between its assets and liabilities, and it represents the bank’s ability to absorb losses.
• There are three different tiers of capital: tier 1, tier 2, and tier 3.