The Federal Reserve has permitted a final rule that caps the amount of credit exposure that the US banks can have to each other and to other counterparties in a bid to strengthen financial stability.

The rule, which was first introduced under the 2010 Dodd-Frank financial reform law, aims to avoid concentrations of risk between large banks and their counterparties from undermining financial stability.

Under the Dodd-Frank Act, the single counterparty credit limits addressed in the rule will include loans, securities, derivatives, lending transactions and certain other transactions. The final rule imposes stricter credit limits based on the systemic importance of the firm.

As per the revised law, a global systemically important bank holding company (GSIB) will not be allowed to credit exposure of more than 15% of the GSIB’s tier 1 capital to another systemically important financial firm.

A bank holding company with $250bn or more in total consolidated assets in the US has been barred from a credit exposure of no more than 25% of its tier 1 capital to all other counterparties.

Similarly, foreign banks operating in the US with $250bn or more in total global consolidated assets, and their intermediate holding companies (IHCs) with $50bn or more in total US consolidated assets, will face the same credit limits.

Federal Reserve chairman Jerome Powell said: “This final rule is another step in sustaining an effective and efficient regulatory regime that keeps our financial system strong and protects our economy while imposing no more burden than is necessary to get the job done.”

Federal Reserve vice chairman Randal Quarles said: “The final rule adds to the robust capital and liquidity positions of the financial system today by setting out clear limits on credit exposures among the largest banking firms. I am pleased by the final rule’s efficient approach to setting limits that are appropriately adjusted for firms of lesser systemic importance.”

The new rule will be applicable for GSIBs from1 January 2020 while all other banks will have to comply with the rule by 1 July 2020.