Concentration Risk

Concentration risk is the danger that too much of a lender's portfolio depends on one thing: one borrower, one industry, one property type, one area or one source of repayment. If that one thing goes wrong, many loans can go bad at once, and losses pile up faster than the lender can absorb them.

Common types include:

• Single borrower or related group. Several loans to one owner and their companies.
• Industry. Heavy lending to restaurants, trucking or another single sector.
• Property type. A large share in office buildings or construction loans.
• Geography. Most loans in one county, or in an area exposed to the same flood or wildfire risk.
• Shared repayment source. Many borrowers who rely on the same big customer or the same guarantor.

Lenders usually measure a concentration as a share of their capital, not just a share of their loans. That shows how much of the lender's cushion is at risk.

Why it matters for lenders

A portfolio of loans that each look sound can still fail together when its main industry or market turns.

US bank regulators give clear reference points. The Office of the Comptroller of the Currency (OCC) defines a concentration as exposure above 25% of a bank's tier 1 capital plus its loss allowance. Interagency guidance from 2006 flags banks for closer review when construction and land loans reach 100% of total capital. It does the same when commercial real estate loans reach 300% of total capital and have grown 50% or more over the prior three years.

Non-bank lenders face the same risk in other forms. A community development financial institution's (CDFI's) funders may set concentration limits in their loan agreements. A private credit fund's investors may cap exposure to any one borrower. Investor reporting often asks for the portfolio split by industry, area and property type.

How it works in practice

A community lender sets limits in its credit policy for any one borrower group, any one industry and construction lending, each as a share of capital. Each month, staff report actual levels against those limits to the credit committee.

Before approving a new hotel loan, the underwriter checks the hospitality total. The new loan would push it past the limit. The committee has three options: decline, approve it as a policy exception with a written reason, or sell part of the loan to another lender through a loan participation. It chooses the participation.

This only works if each loan carries clean data: an industry code, the property type, the location and any related borrowers. In spreadsheets, totals are often stale. On each loan, the data shows current concentrations before every vote.