Bank Failures Shine Spotlight on Concentration Risk
‘A customer base that is too concentrated could react in the same way to market stress’
The takes and takeaways from the failures of Silicon Valley Bank and Signature Bank of New York have been plentiful. But one lesson that rings true across the industry is the need to pay heed to concentration risk.
The concentration of lending and deposits in one area of the economy “always introduces more risk,” Risk Management Association President and CEO Nancy Foster said shortly after regulators announced emergency measures this week to stem spreading bank runs. “Recent events make clear that banking fundamentals, including balance sheet management and addressing concentration risk, remain critical,” Foster said.
It is not uncommon for banks to have certain concentrations, and there can be different types: by geography, by industry, etc. In many cases, a specialty in a particular industry is a source of strength. It builds expertise, boosts the brand, and helps to better attract and serve customers.
But a customer base that is too concentrated could react in the same way to market stress, said Grigoris Karakoulas, president of InfoAgora, a risk analytics firm in Toronto and New York City. And concentration in any sector—agriculture, leisure and accommodation, etc.—can eventually spell trouble. “An idiosyncratic event in such industries might trigger higher deposit outflows in times of stress,” Karakoulas said.
Another element to bear in mind is the potential power of key influencers in client concentrations. Some industries are tight-knit, and their influencers could persuade others to exit relations with a bank—something that can happen quickly in the era of social media and high-speed transactions (see related article below).
Of course, concentrations are a potential danger on the lending side as well. (The FDIC has made available this piece on managing commercial real estate concentration risk.)
Among other risk management measures, Karakoulas suggested that banks “review their asset and liability management (ALM) policy regarding concentration limits on their balance mix and use ALM key performance indicators as early warning signals.”
For more, tune in to RMA’s upcoming Risk Readiness Webcast, “Turmoil in the U.S. Banking System: Potential Implications of the SVB and Signature Bank Collapse,” on Friday, March 17, at 11:30 a.m. Eastern time.