Managing Concentration Risk

Federico Galizia

This article was first published as a chapter in Managing Systemic Exposure, by Risk Books.

It is useful after a crisis to turn back the clock and ask what could have been done differently. This is particularly true for the heady years preceding the onset of the financial turmoil of 2007–09. In this chapter, we will examine a representative credit portfolio that many banks would have owned at the beginning of the new millennium: this is sufficiently far back in time that developments have had a chance to play out, but close enough for senior executives to remember.

The main goal of this chapter will be to illustrate the potential for downside. The essence of risk measurement via a credit value-at-risk (VaR) is to explore what would happen in a crisis scenario, knowing full well that such a scenario was highly unlikely to materialise. A very senior credit officer who had lived through the Scandinavian banking crisis in the 1990s explained this to me as follows: “I am only interested in looking at stress levels that would break my institution, because those are the ones that teach me the most”. Even at the time of writing, with stress testing making headlines on a regular basis