Glossary term
Concentration Risk
Subject: Risk Management, Financial Risk (Credit, Market, Liquidity)
Also known as: Vendor Concentration Risk, Single-name concentration
Concentration risk is the chance of heavy loss because exposure is bunched in one borrower, sector, region, product, funding source or supplier, so one adverse event hits a large share of the business.
Explanation
Diversification spreads risk, and concentration is its opposite. In lending it appears as large exposures to one borrower or group, or to one industry or region. In markets it can be a large position in a single asset. In funding it means relying on a few depositors or one market. Outside finance, vendor concentration arises when a critical service, such as cloud hosting, comes from one provider, and technology concentration when many firms rely on the same software or platform. Limits are normally set by name, sector, country and supplier, and monitored against risk appetite. Regulators often set caps on single large exposures. Concentrations can build quietly, because a profitable segment tempts managers to keep adding to it. Risk committees use concentration limits to decide when to stop adding to a favoured borrower, sector or supplier.
Example
A regional lender finds that 35% of its loan book is to commercial property developers in one city. When a local downturn hits, many loans weaken together. In another case, a retailer runs all its online sales on a single cloud provider, and a four-hour outage stops trading entirely. Neither exposure looked large item by item.
Not to be confused with
- Diversification
- Diversification spreads exposure across many names or sources. Concentration risk is what remains when that spread is too thin.