How Community Bankers Are Managing Concentration Risk

1/11/2024

If 2023 taught us anything, it’s that concentration risk has the potential to sneak up on a bank, especially when economic conditions or industry landscapes undergo rapid shifts. In dynamic environments—and our current environment is nothing if not dynamic—banks may find themselves unintentionally accumulating exposures to specific sectors, geographic regions, or asset classes.

For community banks, which by definition often operate within more localized markets, concentration risk can be particularly pronounced: Downturns or adverse events in the concentrated area may significantly impact the bank’s loan portfolio and overall financial health.

Community bankers from Maine, Rhode Island, and Texas recently shared their concentration risk best practices with RMA. Highlights include:

Keep the board continually informed about potential loan issues and lending decisions. “Having clarity and consistency of reporting, and then throwing candor on top of that—getting out in front of it instead of making people have to ask about it—worked for us,” William Wray, CRO at the Washington Trust Company in Rhode Island, said.
Be aware of concentration risks within sector portfolios. For example, Maine Community Bank didn’t want to “get out over our skis” and finance more seasonal homes than the local market can handle.
Question assumptions to spot potential trouble. Bankers once considered loans for New York City taxi medallions and city center parking lots safe bets until both sectors encountered unexpected pandemic-related problems.

The bankers also expressed concern about the outlook for office loans maturing in the next few years, though they said they continue to make loans for office properties if the numbers make sense.

Concentration risk is also an issue for bank deposits. That was one factor in Silicon Valley Bank’s failure. The bankers recommended a customer mix balanced between commercial and retail deposits for increased security.

To uncover concentration risk problems before they surface, bankers recommended diving deeper into available information, such as examining the tenant strength for a property owner and examining past loan issues.

“Concentrations can creep up from anywhere,” Maine Community Bank Senior Credit Officer Chris Brann said. “The critical lesson we learned is to be deliberate in looking for concentrations.”