Concentrations of Credit

Use Case for Concentrations of Credit

Use Case: All banks have credit concentrations. In some cases, this is by choice as the institution seeks to develop expertise in a particular segment. In other cases, it may be the result of mergers or acquisitions. Alternatively, credit concentrations may be unavoidable due to a lender’s limited geographic footprint combined with its market’s dependence on a relatively few employers or industries. Whatever the reason, it is incumbent on management and the board of directors to ensure that the bank has an effective process in place to identify, measure, monitor, and control concentration risk. The board of directors also needs to ensure that the bank maintains adequate capital relative to concentration risks. Although each individual transaction within a concentration may be prudently underwritten, collectively the transactions are sensitive to the same economic, financial, or business development events. If something triggers a negative development, the risk is that the sum of the transactions may perform as if it were a single, large exposure. Identifying, measuring, and appropriately mitigating concentration risk is ultimately dependent on the accurate and timely receipt and analysis of data. The absence of a sufficiently robust set of data elements will hinder an institution’s ability to identify and monitor concentration risk, regardless of the data’s accuracy and timeliness.

Who Should Assess the Risk? Chief Credit Officer, Chief Lending Officer, Credit Administrator