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.
Table of Contents
1 Introduction
2 The Regional Principle of Sparkassen and Credit Unions in Germany
2.1 Sparkassen
2.1.1 The Regional Principle of Sparkassen
2.1.2 The German Savings Bank group
2.2 Credit Unions
2.2.1 The Regional Principle
2.2.2 The Bundesverband Deutscher Volks- und Raiffeisenbanken (BVR)
2.3 Common aspects of both, Savings Banks and Credit Unions
3 Concentration risks in loan portfolios
3.1 Risk and concentration risk
3.2 Sources of concentration risks in loan portfolios
3.3 Methods to measure concentration risks
3.3.1 Methods to measure name concentration
3.3.2 Methods to measure sector concentration
4 Specialization and „diversification discount“
4.1 The trade off between specialization and diversification
4.1.1 The relationship between Specialization (Monitoring) and Diversification
4.1.2 The incentive to perform monitoring
4.2 Empiric evidence
4.3 Impact on Savings Banks and Credit Unions
5 Risk reduction via new financial products
5.1 Products for Credit Risk transfer
5.2 Specialization without to renounce on advantages of Diversification
5.2.1 Negative affects of „classic“ diversification
5.2.2 Diversification under the use of derivatives
6 Conclusion
Objectives and Themes
This paper examines how the "Regional Principle" influences risk concentration in the loan portfolios of German Savings Banks (Sparkassen) and Credit Unions (Genossenschaftsbanken). It evaluates the trade-offs between geographical specialization and sector diversification, while exploring whether modern financial instruments like derivatives and asset-backed securities can mitigate concentration risks without abandoning the core regional business model.
- Impact of the Regional Principle on bank risk profiles.
- Theoretical and empirical analysis of specialization versus diversification strategies.
- Identification of concentration risks (name, sector, and micro contagion).
- Evaluation of credit risk transfer mechanisms to enhance portfolio efficiency.
Excerpt from the Book
3.1 Risk and concentration risk
„Risk“ in general means nothing else than „uncertainty“. Talking about credit, risk in this context means only the downside part of the whole uncertainty, thus the risk to experience losses. As we cannot see into the future, real life will always bring uncertainty, and every person and institution will never be exempt from it, but considering portfolio theory, it is possible to reduce risk. Furthermore can risk be divided into two categories: Systematic and Idiosyncratic risk.
„Systematic risk represents the effect of unexpected changes in macroeconomic and financial market conditions on the performance of borrowers. Borrowers may differ in their degree of sensitivity to systematic risk, but few firms are completely indifferent to the wider economic conditions in which they operate. Therefore the systematic component of portfolio risk is unavoidable and only partly diversifiable. Idiosyncratic risk represents the effects of risks that are particular to individual borrowers. As a portfolio becomes more fine-grained, in the sense that the largest individual exposures account for a smaller share of total portfolio exposure, idiosyncratic risk is diversified away at the portfolio level. This risk is totally eliminated in an infinitely granular portfolio (one with a very large number of exposures)“
„The term “concentration risk” in the context of banking generally denotes the risk, arising from an uneven distribution of counterparties in credit or any other business relationships or from a concentration in business sectors or geographical regions which is capable of generating losses large enough to jeopardise an institution’s solvency.“
Summary of Chapters
1 Introduction: Outlines the research focus on risk concentration within German Savings Banks and Credit Unions resulting from their regional operational constraints.
2 The Regional Principle of Sparkassen and Credit Unions in Germany: Explains the historical and legal origins of the Regional Principle and why these banking groups operate under similar structural constraints.
3 Concentration risks in loan portfolios: Defines the types of credit risks and details the methodologies used to measure name and sector concentration in bank portfolios.
4 Specialization and „diversification discount“: Analyzes the theoretical conflict between specializing in a region and diversifying across sectors, supported by empirical evidence regarding bank performance.
5 Risk reduction via new financial products: Discusses how financial innovations like derivatives and asset-backed securities allow banks to decouple credit risk from their primary regional operations.
6 Conclusion: Summarizes that specialization is often the most efficient strategy, provided that modern financial instruments are utilized to manage the inherent concentration risks.
Keywords
Regional Principle, Sparkassen, Credit Unions, Concentration Risk, Loan Portfolios, Specialization, Diversification, Risk Management, Credit Derivatives, Asset Backed Securities, Basel II, Portfolio Theory, Idiosyncratic Risk, Systematic Risk, Financial Intermediation.
Frequently Asked Questions
What is the core subject of this research paper?
The paper focuses on the impact of the "Regional Principle" on risk concentration and performance within German Savings Banks and Credit Unions.
What are the central thematic fields discussed?
The main themes include risk management in banking, the trade-off between specialization and diversification, and the utilization of financial derivatives for credit risk transfer.
What is the primary objective of this work?
The objective is to determine under which conditions regional banks should specialize versus diversify, and how new financial products can optimize their portfolios.
Which scientific methodology is primarily applied?
The paper uses portfolio theory and existing empirical studies (such as the work of Acharya, Hasan, and Saunders) to analyze bank performance data.
What topics are covered in the main body of the work?
The main body covers the definitions of the Regional Principle, sources of concentration risk, methods for measuring these risks, and the strategic application of credit risk transfer products.
Which keywords best characterize the research?
Key terms include Regional Principle, Concentration Risk, Specialization, Diversification, Credit Derivatives, and Asset Backed Securities.
How do "classic" diversification and "modern" diversification differ?
Classic diversification often involves entering new, unfamiliar markets, which can lead to increased monitoring costs. Modern diversification uses financial products like ABS to transfer risk without needing to change operational business strategies.
Why are Credit Unions considered "homogenous" to Savings Banks in this context?
Despite different origins and legal forms, both groups follow a similar Regional Principle, have small firm sizes, and operate within stability networks that provide an integrated approach to business and liability.
- 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
