Concentration risk is a banking term denoting the overall spread of a bank's outstanding accounts over the number or variety of debtors to whom the bank has lent money. A banker or bank is a Financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money In Economics a debtor is simply an entity that owes a Debt to someone else the entity could be an individual a firm a government or an organization This risk is calculated using a "concentration ratio" which explains what percentage of the outstanding accounts each bank loan represents. A loan is a type of Debt. This article focuses exclusively on monetary loans although in practice any material object might be lent For example, if a bank has 5 outstanding loans of equal value each loan would have a concentration ratio of . 2; if it had 3, it would be . 333.
Various other factors enter into this equation in the real world applications, where loans are not evenly distributed or are heavily concentrated in certain economic sectors. A bank with 10 loans, valued at 10 dollars a piece would have a concentration ratio of . 10; but if 9 of the loans were for 1 dollar, and the last was for 50, the concentration risk would be considerably higher. Also, loans weighted towards a specific economic sector would create a higher ratio than a set of evenly distributed loans because the evenly spread loans would serve to offset the risk of economic downturn and default in any one specific industry damaging the bank's outstanding accounts.
Risk of default is an important factor in concentration risk. In Finance, default occurs when a debtor has not met its legal obligations according to the debt contract e The basic issue raised by the concept of default risk is: does the risk of default on a bank's outstanding loans match the overall risk posed by the entire economy or are the bank's loans concentrated in areas of higher or lower than average risk based on their volume, type, amount, and industry.
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