Restricting total credit to related parties to a specific percentage of the bank's Tier 1 capital is a prudent approach for managing credit risk exposure to connected entities. This policy aligns with common regulatory practices, which typically set limits on the amount of credit that can be extended to related parties. By setting a cap based on a percentage of Tier 1 capital, the bank ensures that its exposure to related parties remains within a manageable and safe range. This approach helps to mitigate potential conflicts of interest and the risk of preferential treatment, promoting fairness and aligning credit decisions with the bank’s overall risk management framework.

A is incorrect because excluding all related parties from receiving any form of credit can be overly restrictive and may not be practical, especially when there are legitimate business needs for credit among these entities.

B is incorrect because requiring board approval for all credit extensions, regardless of amount, can be excessively burdensome and impractical. It may hinder the bank's operational efficiency without necessarily addressing the underlying risk factors effectively.

D is incorrect because simply applying higher interest rates as a risk premium does not address the core issue of potential conflicts of interest or the risk of preferential treatment in credit decisions related to connected parties.

Things to Remember

• Setting credit limits for related parties as a percentage of the bank's Tier 1 capital is a widely accepted regulatory practice that helps manage credit risk exposure effectively.
• This approach ensures that credit extensions to related parties are made under controlled conditions, avoiding excessive concentration of credit risk within connected entities.