Measuring Concentration Risk - A Partial Portfolio Approach

33 Pages Posted: 9 Dec 2016

See all articles by Pierpaolo Grippa

Pierpaolo Grippa

International Monetary Fund (IMF) - Monetary and Capital Markets Department

Lucyna Górnicka

IMF

Date Written: August 2016

Abstract

Concentration risk is an important feature of many banking sectors, especially in emerging and small economies. 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. Banks are expected to compensate for this by autonomously estimating and setting aside appropriate capital buffers, which supervisors are required to assess and possibly challenge within the Pillar 2 process. Inadequate reflection of this risk can lead to insufficient capital levels even when the capital ratios seem high. We propose a flexible technique, based on a combination of 'full' credit portfolio modeling and asymptotic results, to calculate capital requirements for name and sector concentration risk in banks' portfolios. The proposed approach lends itself to be used in bilateral surveillance, as a potential area for technical assistance on banking supervision, and as a policy tool to gauge the degree of concentration risk in different banking systems.

Keywords: Banking sector, Loan concentration, Credit risk, Capital requirements, Bank regulations, Bank supervision, concentration risk, Basel capital requirements, Pillar 2, Credit VaR

JEL Classification: E44, G21, G32

Suggested Citation

Grippa, Pierpaolo and Górnicka, Lucyna, Measuring Concentration Risk - A Partial Portfolio Approach (August 2016). IMF Working Paper No. 16/158, Available at SSRN: https://ssrn.com/abstract=2882595

Pierpaolo Grippa (Contact Author)

International Monetary Fund (IMF) - Monetary and Capital Markets Department ( email )

700 19th St NW
Washington, DC 20431
United States

Lucyna Górnicka

IMF ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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