The implication of concentration risk is that it generates such a significant loss that recovery is unlikely. Events during the 20082009 financial crisis have brought to light many examples of risk concentrations within institutions. Nevertheless, concentration risk is a fundamental matter in a number of operational areas, including outsourcing. Pdf the measurement of concentration risk in loan portfolios. However, if an associations sole method of analyzing its concentration exposures is to exclude this volume, the institution is understating its concentration risk exposure.
Existing multifactor models that deal with concentration risk are often inconsistent with the pillar 1 capital requirements. Assessing the gap between aggregate and detailed data 1 concentration indicators. Risk analysis depends to a large extent on the type of data. Concentration measures in risk management article pdf available in journal of the operational research society 645 may 20 with 308 reads how we measure reads. Establish procedures for measuring and monitoring liquidity. Events during the 20082009 financial crisis have brought to light many examples of risk concentrations. The research goal is to investigate the measurement of loan concentration risk in banks. In financial mathematics, a risk measure is used to determine the amount of an asset or set of assets traditionally currency to be kept in reserve.
In section 4 we set out our proposal for measuring sector concentration risk. Measuring concentration risk for regulatory purposes. For both name and sector concentration a full monte carlo method is implemented but as this is a time consuming method, alternative methods are suggested. Concentration risk is one of the main possible causes of major losses in a credit institution. Evidence of concentration risk in polish banks credit exposures1 natalia nehrebecka2 abstract in recent years, there has been a lot of scientific research stressing the importance of understanding and measuring concentration risk in credit portfolios.
This paper gives an overview and compares various approximation methods that measure the capital impact of risk concentrations in the context of. The measurement of concentration risk in credit portfolios is necessary for the determination of regulatory capital under pillar 2 of basel ii as well as for managing portfolios and allocating economic capital. Risk measurement and systemic risk european central bank. Morgan for the measurement, management, and control of credit risk in its own activities.
Measurement and capital adequacy market risk page 2081. An association that opts to measure its risk exposures by including all such program volume in its concentration statistics is not a concern. Credit concentration risk can be split into name and sector concentration and two models are evaluated for each type of concentration risk. In section 3 we focus on concentration risk, differentiating between name concentration risk and sector concentration risk. Concentration risk is the potential for a loss in value of an investment portfolio or a financial institution when an individual or group of exposures move together in an unfavorable direction. In this chapter, we look at how risk measures have evolved over. The measurement of concentration risk in credit portfolios is necessary for the determination of regulatory capital under pillar ii of basel ii as well as for managing portfolios and allocating economic capital. Items addressed generally include funding types with similar rate sensitivity or volatility, such as brokered or internet deposits and deposits generated through promotional offers. Concentration risk is an important feature of many banking sectors, especially in emerging and small economies. Concentration risk investment portfolio, portfolio. Causes of concentration risk and methods that are used to measure concentration risk are also examined in this article. Ford b ankers and regulatory agencies use limits on the size of individual credits as a device to control the risk of the loan portfolio. Practical aspects mindaugas juodis is a doctor of physical sciences, credit risk expert of credit risk control unit at seb lithuania and seb baltic banks credit risk competence center. Measuring concentration risk for regulatory purposes by.
The institution should establish a risk management framework to adequately identify, measure, evaluate, monitor, report and control or mitigate credit risk. To quantitative financial experts, variance is a commonly used proxy for risk. The third part of this article analyses how the loan portfolio changed in lithuanian banks during 2004 2010 years. This is the case, for instance, for concentration risk or for certain aspects of liquidity risk, when liquidity is understood as the ability of a ucits to meet, at a reasonable cost, its obligations redemptions or debt reimbursement as they become due. Measurement and capital adequacymarket risk page 2082 only the hebrew version is binding a. Managing and monitoring a single view of concentration risk. The asrf model and concentration risk outline 1 portfolio credit risk modeling 2 haar wavelets for laplace transform inversion 3 the wa method to quantify losses 4 credit risk contributions 5 the wa extension to the multifactor model 6 conclusions luis ortiz gracia ub name concentration risk and its measurement 267. Cespedes et al 2005 developed an adjustment to the single risk factor model in the. The purpose of this reserve is to make the risks taken by financial institutions, such as banks and insurance companies, acceptable to the regulator. Under the basel framework, pillar 1 capital requirements for credit risk do not cover concentration risk, and those calculated under the internal. Concentration risk was originally a term that banks used to describe credit risk in the form of lending too much to one particular customer or type of customer such as companies in a particular industry. Alexander barvinok these are daybyday lecture notes, not. In order to achieve the research goal, the research tasks are set as follows.
A tractable model to measure sector concentration risk in. Value at risk var is a statistical measure used to assess the level of risk associated with a portfolio or company. Concentration risk can be defined as any single direct andor indirect exposure or group of exposures with the potential to produce losses large enough to threaten an institutions health or its ability to maintain its core business. Although many of the considerations in this paper are directly applicable to relationships with suppliers of goods, the primary focus of this paper is on concentration risk in outsourcing relationships with thirdparty service. Lutkebohmert 2009 suggests a definition of the concentration risk intothe credit portfolio. The remainder of the paper has been structured as follows. Under the basel framework, pillar 1 capital requirements for credit risk do not cover concentration risk, and those calculated under the internal ratings based irb approach explicitly exclude it.
Rating agencies recognize singlename concentration in their ratings methodologies and highlight concentration risk as potential ratings negative. Measure concentration alexander barvinok these are daybyday lecture notes, not really proofread or edited and with no references, for the course that i taught in winter 2005 term. Risk is essentially the standard deviation of return on an asset of portfolio. The easiest way to conceive a concentration measurement is to calculate the accumulation of the largest expo. Existing multifactor models that deal with concentration risk are often inconsistent with the pillar i capital requirements. Determining regulatory capital under pillar ii of basel ii. Measuring concentration risk very often, the best way to evaluate concentration risk in a credit portfolio is to go through the list of the top 20 exposures, analyzing information such as the counterparty rating, its group, sector and country, and the average recovery rate associated with existing exposures.
Banking standards for monitoring and controlling large exposures have uncovered a need for tools that can streamline credit risk management systems and create a single enterprisewide view of risk as an early warning system against future crises managing concentration risk is certainly not a. Risk measurement and systemic risk april 2007 preface the fourth joint central bank research conference on risk measurement and systemic risk took place at the european central bank in frankfurt on 8 and 9 november 2005. Concentration risk in credit portfolios is woven into the credit risk of the portfolio and, therefore, implicitly accounted for in bestpractice multifactor portfolio models applied in the industry. One of the key reasons for the 2008 global nancial crisis was banks failure to adequately measure and control their exposures to individual and connected. In this context, this article analyses definition and importance of concentration risk in the loan portfolio. The var measures the maximum potential loss with a degree of confidence for a specified period. Concentration risk in the loan portfolio, depending on the loans given for different sectors of economic activity, is measured in this article as well. Market risk is defined as the risk of losses in on and offbalancesheet positions arising from movements in market prices. Sector concentration in loan portfolios and economic capital. In recent years attention has turned towards convex and coherent risk measurement. In the standard risk based capital framework, the risk mitigation measures are oriented toward individual counterparties. Concentration risk measures marginal risk reduction mrr if premium in a region is reduced by 10k, how much will pml decrease. Risk concentrations can arise in a financial conglomerates assets, liabilities or offbalance.
Provide a method of computing the banks cost of funds. A risk concentration refers to an exposure with the potential to produce losses large enough to threaten a financial institutions health or ability to maintain its core operations. Risk 53 fr 2485024869, proposed guidelines for exposurerelated measurements 53 fr 4883048853, and proposed amendments to the guidelines for the health assessment of suspect developmental toxicants 54 fr 93869403. Assessing the gap between aggregate and detailed data. October 2006 abstract this paper explores a simplified version of the analytic valueat risk approximation. For name concentration risk the alternative method. Direct measure of risk reduction by deconcentration deconcetration strategy. Measuring concentration risk a partial portfolio approach. In evaluating the bank wide measures in managing concentration risk, we demonstrate how economic capital approach may enable the bank to assess the impact of regional, industry and individual concentration. Granularity adjustment for regulatory capital assessment. For example, suppose a portfolio of investments has. The conference was hosted by the ecb in cooperation with the bank of japan and the board of. If you accept the argument that risk matters and that it affects how managers and investors make decisions, it follows logically that measuring risk is a critical first step towards managing it.
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