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CEBS Guidelines on the Management of Concentration Risk under the Supervisory Review Process (GL31)

Core Content

These CEBS Guidelines (GL31) provide a comprehensive framework for managing concentration risk in credit institutions. They are part of the supervisory review process under Pillar 2 of the Capital Requirements Directive (CRD) and aim to ensure that institutions identify, measure, monitor, and mitigate concentration risk effectively.

Main Points

• Definition of Concentration Risk:
  Concentration risk refers to exposures that may lead to significant losses or a material change in an institution's risk profile. It is divided into two types:

  • Intra-risk concentration: Concentrations within a single risk category.
  • Inter-risk concentration: Concentrations across different risk categories, often due to common risk drivers or interdependencies.

• Scope and Relevance:
  The guidelines cover all aspects of concentration risk, including credit, market, operational, and liquidity risks. They also address business concentration and earnings structure, emphasizing the importance of considering interdependencies between different sources of income.

• Holistic Approach:
  A holistic approach is promoted, where concentration risk is not treated in isolation but as a single event that can affect multiple risk categories. Institutions are expected to integrate concentration risk management across all risk areas.

• Proportionality Principle:
  The principle of proportionality is central to the guidelines. Smaller and simpler institutions may focus more on qualitative aspects, while larger and more complex institutions must capture both intra- and inter-risk concentrations in their internal models.

• Integration with Risk Management Frameworks:
  Institutions are required to have clear policies, procedures, and governance structures for managing concentration risk. These should be embedded in the overall risk management culture and regularly reviewed.

• Monitoring and Reporting:
  Institutions must establish a comprehensive monitoring and reporting framework to track concentration risk at both group and solo levels. This includes the use of internal limits, triggers, and indicators to ensure timely and accurate information is provided to management.

• Stress Testing:
  Stress testing is a key tool for identifying concentration risk. It should be used to assess both the impact of concentration risk on the institution and the interdependencies that may arise under stressed conditions.

• Supervisory Role:
  Supervisors should consider the business model and strategy of institutions when assessing concentration risk, especially in cross-border groups. They are expected to engage in the ICAAP-SREP dialogue to ensure effective risk management.

Key Information

• Implementation Deadline:
  The guidelines were expected to be implemented by CEBS members by 31 December 2010, through national supervisory guidelines and manuals.

• Annexes:
  The guidelines are supplemented by two annexes:

  • Annex 1: Examples of concentration risk.
  • Annex 2: Examples of indicators used for concentration risk management.

• Inter-risk Concentration:
  Inter-risk concentrations can occur when exposures are not booked in the same place (e.g., banking book and trading book), and may become more pronounced during stress periods due to correlations between risks.

• Mitigation Techniques:
  Institutions should use appropriate mitigation techniques such as diversification, risk transfer instruments, and changes in business strategy. However, they must ensure that these techniques are effective and do not lead to a substitution of one type of concentration for another.

• Supervisory Review:
  The supervisory review process should consider both the institution's risk profile and its business model. CEBS encourages the use of stress testing and scenario analysis to assess concentration risk across the entire organization.

Structure of the Guidelines

The guidelines are structured into five main sections:

1. Background and Introduction
2. Definition of Concentration Risk
3. General Considerations and Principles
4. Management and Supervision within Individual Risk Areas
5. Supervisory Review and Assessment

Each section includes detailed explanations, principles, and recommendations for managing concentration risk across different risk categories.

Conclusion

GL31 emphasizes the importance of a proactive and integrated approach to concentration risk management, recognizing its potential to threaten the stability of credit institutions. By addressing both intra- and inter-risk concentrations, the guidelines aim to ensure that institutions are well-prepared to manage and mitigate concentration risk, aligning with the broader objectives of the CRD and Pillar 2 framework.