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SC5-Chapter 12-Credit Risk-Loan Portfolio and Concentration Risk2

# SC5-Chapter 12-Credit Risk-Loan Portfolio and Concentration Risk2

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3/17/11 11 Systematic Loan Loss Sensitivity α Loss on Loan Portfolio Loss on Loans of Category i Slope = β LLP LLCi

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3/17/11 22 SC5-Chapter 12, End-of- Chapter Question 16 ABC bank is trying to implement loan concentration limits on its consumer (CON) and commercial (COM) loan segments of its loan portfolio. After deciding to use a systematic loan loss approach, ABC has estimated the following regression equations for the two loan segments: L CON L COM X 1.8 0.003 X and X 0.8 002 . 0 X + = + =
3/17/11 33 SC5-Chapter 12, End-of-Chapter Question 16 If the overall loss rate in ABC Bank’s loan portfolio is expected to be 10%, what are the expected loss rates their two loan segments? 18.3% or 83 0.1 (.10) 1.8 0.003 X 8.2% or 0.082 (.10) 0.8 0.002 X CON COM = + = = + = Thus the consumer loan segment will be much more sensitive to overall losses in ABC Bank’s loan portfolio and should therefore receive a lower concentration limit.

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3/17/11 44 Concentration Limit Analysis Loan Concentration Risk refers to the additional risk the bank takes on as a result of heavy loan concentration in a firm, industry, economic sector or geographic market a well diversified loan portfolio will limit loan concentration risk
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