Concentration Risk

From Open Risk Manual

Definition

Concentration Risk is a general term denoting a condition where excess Concentration of a value or attribute of a system is the cause of Risk. The concept is applicable across various risk types and may signify excessive dependence and/or sensitivity on specific risk factors. Managing concentration risk in its various manifestations is typically one of the key objectives of Risk Management or Portfolio Management.

Concentration Risk Taxonomy

The Concentration Risk Taxonomy mirrors broadly the general Risk Taxonomy, except that not all risk types exhibit the characteristics that may turn the concepts of concentration risk into useful tools. Indicatively

Regulatory Expectations

For regulated firms concentration risk is in the scope of [[Pillar II] and the SREP process. The scope and methodology of the Pillar II assessment of this risk differs from jurisdiction to jurisdiction. All supervisors expect banks to consider the impact of concentration risk, and all supervisors have developed approaches or methodologies for assessing concentration risk. [1]

The majority of supervisors have done so through a combination of off-site monitoring and on-site examination. Some supervisors use off-site monitoring only, and some supervisors consider input from supplementary audits performed by audit firms. The majority of supervisors undertake on-site inspections focused on concentration risk as a part of an inspection on credit risk. Off-site monitoring is performed mainly through regulatory reporting

The majority of supervisors use quantitative methods for assessing concentration risk, but other elements are factored in as well: elements from regulatory reporting, ICAAP, banks’ analyses and reports, peer reviews and other qualitative information. One jurisdiction assesses concentration risk based solely on a quantitative method, which is applied automatically and translated into a Pillar II capital expectation

Regarding indices and thresholds for the assessment and monitoring of concentration risk, about half of supervisors use the Herfindahl-Hirschman Index (HHI), a few supervisors incorporate the [[Gini Index}} and a handful of supervisors also use internal supervisory models. For one supervisor, the indices are different according to the bank’s business model. Some supervisors are planning to introduce, or considering introducing, the HHI into their concentration risk assessments. Finally, a few supervisors do not have a specific quantitative method for assessing concentration risk but rather rely on other means for assessing that risk, such as banks’ ICAAPs.

All supervisors apply some type of large exposure limit, and the majority of supervisors plan to incorporate concepts from the Basel Committee’s Large Exposures Framework into the assessment of credit risk concentration. Among supervisors that set Pillar II capital expectations, only a few set explicit Pillar II capital expectations for concentration risk. It is more common for supervisors to consider concentration risk together with other risks assessed as part of the Pillar II process.

References

  1. Basel Committee on Banking Supervision, "Overview of Pillar 2 supervisory review practices and approaches", June 2019

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