Country Limit

What Are Country Limits?

In banking, a country limit refers to a limit placed by a bank on the amount of money that can be lent to borrowers in a particular country. Bank limits are similar to the industry limits used by some stock investors to manage their exposure to specific industry sectors. By limiting their exposure to any one country, a bank can reduce their exposure to a potential national crisis.

Understanding Country Limits

A country limit is a ceiling on the aggregate value of loans and other banking activities in a given country. They typically apply to all borrowers, regardless of whether they are public or private, individual or institutional.

Country limits also apply to all kinds of loans, including mortgages, business loans and lines of credit (LOCs), and any other forms of borrowing. Some banks may apply further sub-limits to specific market sectors or business activities, such as securities or currency trading. Although banks will also examine other factors when granting loans, country limits are not affected by these factors.

The intention behind a country limit is to help banks ensure that their risks are geographically diversified. If a significant share of a bank's loan portfolio is concentrated in just a few foreign countries, the bank may be unduly exposed to political, economic, and currency risks associated with those countries. Therefore, banks use country limits to diversify their geographic risks just as investors seek to diversify their stock portfolios.

How Banks Set Country Limits

Each bank establishes a formal procedure to create risk ratings for each country where they do business. These risk ratings are then used to establish country limits.

Economic stability is a major factor in country risk. Countries with strong and diversified economies may be given a higher country limit since there is a lower perceived risk of a nationwide crisis. Some banks might not assign country limits to "very low risk" countries, such as France or Germany.

Political stability is another major concern because unrest can cause cascading defaults, regardless of the stability of individual borrowers. In fact, even in stable countries, the political climate is an important element of country risk, because a nation's political climate has a strong influence over its financial stability and economic policies.

Banks also consider countries' regulatory environments when determining country risk. Generally speaking, banks prefer to operate in countries with fewer regulations and a lower cost of compliance. On the other hand, countries with underdeveloped regulatory systems may be susceptible to high rates of fraud and corruption.

Credit Risk Management

While country limits dictate how much money a bank is willing to lend to borrowers in a given country, borrowers are still subject to careful scrutiny before receiving a loan. Personal and institutional borrowers are subject to credit checks, and banks will generally try to choose low-risk borrowers. Some banks may impose sub-limits for specific market sectors or business activities.

Examples of Country Limit

For U.S. banks, country limits are generally highest in relation to countries whose economies and political systems are perceived to be relatively predictable and robust. Examples include the members of the Group of Seven (G7), such as the United Kingdom (U.K.), Germany, and Canada. Some Asian countries, such as Japan or South Korea, are also likely to receive relatively high country limits due to their strong economies and stable political climates.

Banks may also raise country limits if they feel that a particular country or region is poised for significant economic growth. For instance, countries such as China and India may see increased country limits in the years ahead as their share of global gross domestic product (GDP) continues to climb.