Quantification of concentration in bank portfolio

Abstract

Successful economy always depends on its financial system which helps in wealth creation anddistribution. One crucial factor which decides efficiency of financial system is its solvency. Manyinternal and external regulations exist to ensure that a financial institution keeps enough capitalto steer through in case of default or crisis and creates minimal of panic in stakeholders. Failureof a financial institution is bad for economy because along with its own assets it creates hole insaving of individuals exposes them to risk and creates lasting impact on saving of economy.Basel II Norms adopted by various Financial Institutions across globe in 2007 allows banks touse internal credit risk models to estimate required capital. Basel II norms are based on threenorms:1. Minimum Capital Requirement: Gave new way to estimate capital requirement for credit risk in banking bookwhich reflects credit rating of counterparties. It estimates capital for credit,market and operational risk.2. Supervisory Review: It is concerned with supervisory review process, allows regulators to use somediscretion in application of rule in specific country. Internal capital assessmentprocess (ICAP) and supervisory review and evaluation process (SREP) involvesrisks assessment not covered under Pillar I ; such as concentration risk, legaland compliance, technology, liquidity etc by bank on its own.3. Market Discipline: It requires banks to disclose more information about the way they allocatecapital and risks they take.