1 Introduction
Risk Concentration in loan portfolios endanger the safeness of banks and reduce their profitability. Savings Banks and Credit Unions, as small banks which are specialized on geographic regions, are supposed to show high risk concentration in their loan portfolios and perform weakly.
This paper will analyse the consequences of the “Regional Principle“ of the German Savings banks and Credit Unions on the risk concentration in their loan portfolios. One main subject is to show the positive and negative impacts of both strategies, specialization and diversification, on risk concentration, and to explain under which circumstances a bank should decide to specialize or to diversify. Furthermore possibilities will be presented to profit from both strategies thanks to credit risk tranfer by new financial products. The Regional Principle, its origin and and how it determines the strategy of Savings Banks and Credit Unions will be observed in the first part. Further I will explain why they can be considered as a homogenous group of banks. Within the second part will be presented the importance and the sources of concentration risks. Under which circumstances a Financial Institute should specialize or diversify, advantages and disadvantages and the trade off between both strategies will be presented in chapter three. As Savings Banks and Credit Unions would be better off within a regional diversification strategy, in chapter five will be presented the possibility of diversification under the use of derivatives and asset backed securities. Finally the paper will end with a conclusion considering results in wider context of Savings
Banks and Credit Unions.
Inhaltsverzeichnis (Table of Contents)
- Introduction
- The Regional Principle of Sparkassen and Credit Unions in Germany
- Sparkassen
- The Regional Principle of Sparkassen
- The German Savings Bank group
- Credit Unions
- The Regional Principle
- The Bundesverband Deutscher Volks- und Raiffeisenbanken (BVR)
- Common aspects of both, Savings Banks and Credit Unions
- Sparkassen
- Concentration risks in loan portfolios
- Risk and concentration risk
- Sources of concentration risks in loan portfolios
- Methods to measure concentration risks
- Methods to measure name concentration
- Methods to measure sector concentration
- Specialization and „diversification discount“
- The trade off between specialization and diversification
- The relationship between Specialization (Monitoring) and Diversification
- The incentive to perform monitoring
- Empiric evidence
- Impact on Savings Banks and Credit Unions
- The trade off between specialization and diversification
- Risk reduction via new financial products
- Products for Credit Risk transfer
- Specialization without to renounce on advantages of Diversification
- Negative affects of „classic“ diversification
- Diversification under the use of derivatives
- Conclusion
- References
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This paper analyzes the effects of the "Regional Principle" on the concentration risk in loan portfolios of German Savings Banks and Credit Unions. The main objective is to understand the impact of specialization versus diversification strategies on risk and profitability within this specific banking context. The paper aims to identify optimal strategies and explore how new financial products can mitigate risks. * The Regional Principle of German Savings Banks and Credit Unions. * Concentration risk in loan portfolios and its measurement. * The trade-off between specialization and diversification in risk management. * The use of new financial products to manage concentration risk. * The impact of these strategies on the profitability and safety of the institutions.Zusammenfassung der Kapitel (Chapter Summaries)
Introduction: This introductory chapter establishes the central problem: concentration risk in the loan portfolios of German Savings Banks and Credit Unions (Sparkassen and Genossenschaftsbanken) due to their regional focus. It highlights the paper's objectives, which include analyzing the implications of the "Regional Principle," examining the advantages and disadvantages of specialization versus diversification, and exploring risk mitigation strategies through new financial products. The chapter lays out the structure of the subsequent analysis, indicating how each section will contribute to a comprehensive understanding of the research question. The core issue is the inherent trade-off between the benefits of specialized local knowledge and the dangers of over-reliance on a limited geographical area.
The Regional Principle of Sparkassen and Credit Unions in Germany: This chapter delves into the "Regional Principle" that governs the operations of Sparkassen and Genossenschaftsbanken. It examines the historical and structural aspects of this principle, tracing its origins and explaining how it shapes the lending strategies of these institutions. The chapter also establishes the degree of homogeneity within these two banking groups, highlighting commonalities in their operational models and market positions. Detailed discussion of the organizational structures and legal frameworks underpinning the regional principle is provided, laying the groundwork for the analysis of the resulting concentration risk in later chapters. By clarifying the origins and structure of the regional principle, this chapter sets the stage for a deeper understanding of the implications for loan portfolios.
Concentration risks in loan portfolios: This chapter defines and explains concentration risk, differentiating it from general risk. It then identifies the sources of concentration risk within the loan portfolios of Sparkassen and Genossenschaftsbanken, linking these sources directly to the "Regional Principle" discussed in the previous chapter. The chapter also introduces methodologies for measuring concentration risk, focusing on both name concentration (borrower concentration) and sector concentration (industry concentration). The detailed explanation of various methodologies (e.g., Herfindahl-Hirschman Index) allows for a more rigorous assessment of the risk levels present in the institutions' portfolios.
Specialization and „diversification discount“: This chapter explores the trade-off between specialization and diversification in the context of risk management for financial institutions. It analyzes how specialization, while enhancing monitoring capabilities and potentially reducing information asymmetry, also increases exposure to concentration risk. Conversely, the chapter discusses the potential "diversification discount," where excessive diversification can lead to decreased monitoring effectiveness and higher overall risk. Empirical evidence is presented to support the theoretical arguments, demonstrating the real-world implications of this trade-off. A crucial part of this chapter is to determine whether Sparkassen and Genossenschaftsbanken's regional focus is an optimal strategy considering these conflicting tendencies.
Risk reduction via new financial products: This chapter examines strategies for mitigating concentration risk through the use of innovative financial products. It focuses on credit risk transfer mechanisms such as asset-backed securities (ABS), collateralized debt obligations (CDOs), and other securitization techniques. This chapter suggests ways in which Sparkassen and Genossenschaftsbanken can achieve a degree of diversification without entirely abandoning the benefits of their regional focus. The chapter specifically addresses how derivatives can be used to achieve diversification without the downsides of conventional diversification strategies. It aims to demonstrate that banks can effectively exploit both specialization and diversification simultaneously, leading to a superior risk-return profile.
Schlüsselwörter (Keywords)
Concentration risk, regional principle, German Savings Banks (Sparkassen), Credit Unions (Genossenschaftsbanken), diversification, specialization, loan portfolios, risk management, financial products, credit risk transfer, asset-backed securities, derivatives, monitoring, information asymmetry.
Frequently Asked Questions: Analysis of Concentration Risk in German Savings Banks and Credit Unions
What is the main topic of this paper?
This paper analyzes the effects of the "Regional Principle" on concentration risk in the loan portfolios of German Savings Banks (Sparkassen) and Credit Unions (Genossenschaftsbanken). It examines the trade-off between specialization and diversification strategies and explores how new financial products can mitigate risks.
What is the "Regional Principle"?
The "Regional Principle" governs the operations of Sparkassen and Genossenschaftsbanken, focusing their lending activities within specific geographic regions. This chapter details the historical and structural aspects of this principle, its impact on lending strategies, and commonalities within these banking groups.
What are the key themes explored in this paper?
Key themes include: the Regional Principle's influence on concentration risk; methods for measuring concentration risk (name and sector concentration); the trade-off between specialization (with its benefits in monitoring) and diversification; and the use of new financial products (like asset-backed securities and derivatives) to manage concentration risk and achieve effective diversification without sacrificing the advantages of regional focus.
How is concentration risk defined and measured in this paper?
Concentration risk is defined and differentiated from general risk. The paper identifies its sources within the loan portfolios of Sparkassen and Genossenschaftsbanken, linking them to the Regional Principle. Methodologies for measuring both name concentration (borrower concentration) and sector concentration (industry concentration) are introduced and explained, including specific methods like the Herfindahl-Hirschman Index.
What is the "diversification discount," and how does it relate to specialization?
The "diversification discount" refers to the potential negative impact of excessive diversification, leading to decreased monitoring effectiveness and potentially higher overall risk. The paper explores the trade-off between specialization (enhancing monitoring and potentially reducing information asymmetry) and diversification, examining the potential benefits and drawbacks of each approach in the context of German Savings Banks and Credit Unions.
How can new financial products reduce risk?
The paper examines how innovative financial products, such as asset-backed securities (ABS), collateralized debt obligations (CDOs), and other securitization techniques, can mitigate concentration risk. It specifically discusses how derivatives can be used to achieve diversification without the downsides of conventional diversification strategies, allowing institutions to leverage both specialization and diversification for improved risk-return profiles.
What are the main findings or conclusions of the paper?
The concluding chapter summarizes the analysis, drawing together the findings on concentration risk, specialization versus diversification, and risk mitigation strategies. It offers insights into optimal strategies for German Savings Banks and Credit Unions, balancing regional focus with effective risk management.
What are the key words associated with this research?
Key words include: Concentration risk, regional principle, German Savings Banks (Sparkassen), Credit Unions (Genossenschaftsbanken), diversification, specialization, loan portfolios, risk management, financial products, credit risk transfer, asset-backed securities, derivatives, monitoring, information asymmetry.
What is the overall objective of this research?
The main objective is to understand the impact of specialization versus diversification strategies on risk and profitability within the specific banking context of German Savings Banks and Credit Unions, identifying optimal strategies and exploring how new financial products can mitigate risks associated with their regional focus.
- Quote paper
- Dominik Stephan (Author), 2008, Concentration Risks in the Loan Portfolios of the German Savings , Munich, GRIN Verlag, https://www.grin.com/document/94096
