Credit Risk Concentration
Definition
Credit Risk Concentration refers to disproportionally large risk exposure to specific credit risks (as opposed to a diversified risk profile).
Regulatory frameworks generally recognize the following specific concentrations risks:
Data Requirements
Measuring credit risk concentration requires detailed information about Exposure (loan level data, accurate sector assignement etc.)
Calculation
There is a large variety of approaches for measuring Concentration Risk. At is simplest it can calculated using a "concentration ratio" which explains what percentage of the outstanding total risk is represented by the largest exposure. For example, if a bank has 5 outstanding loans, with four of equal value and the fifth having twice the value, then the concentration ratio is 1/3. Slightly more sophisticated concentration indicators are e.g. the Herfindahl-Hirschman Index and the Gini Index
Various other considerations may enter into concentration when applying risk analysis in real world applications, most notably:
- the definition of individual exposures and the related entity aggregation of exposure
- the definition of industrial sectors and allocation of portfolio to sectors
- the relative riskiness of exposures expressed e.g., in terms of the probability of default or the expected loss
Mitigation
Credit concentration risk can be controlled with risk management tools such as:
- Individual limits for name concentration
- Higher level industry and country limits
- Hedging of exposures
- Outright sales of exposures
Issues and Challenges
- There can be more esoteric forms of concentration risk, for example product concentration which may overlap in part with other forms of concentration
