Measuring Concentration Risk - A Partial Portfolio Approach
IMF Working Papers, August 2, 2016
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Bibliographic details
- Authors: Pierpaolo Grippa, Lucyna Gornicka
- Published: August 2, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475523171.001
Summary
- 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 concentration risk can lead to insufficient capital levels even when the capital ratios seem high.
- The paper proposes 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 use 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.
Key Findings and Contributions
- The paper identifies gaps in the Basel capital framework with respect to concentration risk coverage under Pillar 1 and the IRB approach.
- It emphasizes the supervisory role under Pillar 2 to assess banks’ own capital buffers for concentration risk.
- It offers a methodological contribution: a hybrid technique combining full credit portfolio modeling and asymptotic results to quantify capital requirements for name and sector concentration.
Methodology (brief)
- Combines “full” credit portfolio modeling with asymptotic results to evaluate capital charges attributable to name concentration and sector concentration in bank portfolios.
- Intended as a flexible technique applicable across different banking systems and supervisory contexts.
Policy Implications and Uses
- Use in bilateral surveillance to assess banking system concentration risk.
- Potential area for technical assistance on banking supervision.
- Tool for supervisors and policymakers to gauge the degree of concentration risk and to guide Pillar 2 deliberations on capital buffers.