What Is an Excess Loan?

An excess loan is a loan made by a national or state-chartered bank to an individual who is over the loan lending limit as established by law. The legal lending limit establishes the rule that national banks and savings associations cannot lend more than 15% of their capital to any one borrower, plus an additional 10% limit if they qualify. Regulators want banks to lower their risk of loan default by not making large loans to individual borrowers in this way.

Key Takeaways

  • An excess loan is a loan made by a financial institution to a person who is over the loan lending limit determined by law.
  • National banks or savings associations can lend a maximum of 15% of their capital to an individual borrower, plus up to 10% if the person meets certain qualifications.
  • Making an excess loan puts the bank's board of directors at risk for having to be personally liable for the loan if the borrower defaults. As a result, banks are extremely conservative and tend to stick to lending limits.

How an Excess Loan Works

Generally, banks must consider aggregate liability when calculating the lending limit for a single borrower. A borrower’s aggregate liability refers to all of the outstanding loan balances, overdrafts, letters of credit, guidance lines, internal guidance lines, unused commitments, and other liabilities that the borrower carries with that bank. A bank must take an individual borrower’s entire aggregate liability into account in order to avoid an excess loan.

There are some exceptions to aggregate-liability rules, however, mostly based on combination rules. The Federal Deposit Insurance Corporation’s 12 CFR Part 32.5 defines the combination rules and details on what to combine and when in order to determine a borrower’s aggregate liability.

The calculation may be more complicated than simply adding up a borrower’s total debt from all loans, overdrafts, lines of credit, and other obligations. For example, special rules may be in effect for loans made to business partnerships or regarding multiple loans combined to purchase a single asset.

How Do Banks Use Excess Loans?

If a bank chooses to make an excess loan, the bank’s board of directors could become personally liable for the loan in the event that the borrower goes into default. This means that most banks are extremely conservative in calculating aggregate liability and adhering to lending limits. For most banks, aggregating all extensions of credit to individual borrowers or related borrowers—even to loosely related borrowers—is considered a prudent means of avoiding excess loans and the personal liability that comes attached to them.

However, if a bank’s director guarantees a loan in order to use their financial strength to upgrade it, that loan may be excluded from those for which they are personally, contingently liable when calculating aggregate liability for adherence to the legal lending limit.