2. Bank supervisors have traditionally paid close attention to the avoidance of risk concentration by the banks under their jurisdiction. Risk concentration can take a variety of forms. Besides credit exposure, risk concentration can also, for example, involve overexposure to market risks or excessive funding risk when a bank is particularly reliant on a segment of the market as a source of funds. Some forms of risk concentration are not easily capable of objective measurement despite their considerable importance to the supervision of individual banks. Moreover, the fact that banks are often specialists in a particular field may mean that the business earns above average profits, even if there is an above average risk if external factors become less favourable. Experience suggest that credit concentrations, on the other hand, can result in substantial losses without necessarily any commensurate increase in prospective returns. The Basle Committee believes that it is important for supervisors to consider measures limiting banks' exposures to concentrated forms of credit risk in general and large borrowers in particular.
3. While the primary purpose of seeking some convergence in national approaches to the supervision of large exposures is the need to address what is probably the major single cause of bank failures, the present study follows naturally from the Capital Accord of July 1988 which set capital standards for large international banks. It would seem reasonable to build on this work by seeking to define what levels of credit concentration should be regarded as acceptable in relation to capital as defined in the July 1988 paper, while recognising that there needs to be scope for variation according to local conditions.
4. There are several difficult conceptual questions which need to be addressed in measuring and controlling large credit exposures. These include:
- the definition of a credit exposure;
- the definition of a single counterparty or group of related counterparties;
- the appropriate level for a lending limit and a reporting threshold;
- risks arising from an over-concentrated or "clustered" loan book;
- risks arising from excessive exposure to individual geographic areas or economic sectors.
5. The analysis which follows considers each of these problems separately. It may also be noted at this stage that some countries also have credit information exchanges. Albeit designed to gather information on borrower indebtedness rather than on the exposure of lenders, such data bases can give additional insights into the credit risk being run by banks.
