Is Your Loan Portfolio Really Diversified?

By Ross, Paul | American Banker, October 2, 1992 | Go to article overview

Is Your Loan Portfolio Really Diversified?


Ross, Paul, American Banker


A key lesson that lenders learned during the 1980s is that active and careful portfolio management is crucial to credit policy.

Furthermore, as the course of the economy is always uncertain, diversification of the loan portfolio is necessary to safeguard lending performance.

But assessing the diversification of a loan portfolio presents difficulties.

A key problem is risk covariance -- the tendency of different segments of a portfolio to behave similarly in response to economic events. This can make a seemingly well-diversified portfolio highly vulnerable to a particular event, rendering it poorly diversified in reality.

Reasons for Covariance

The most obvious source of risk covariance relates to regional economic interdependencies.

The power of regional covariance was dramatically illustrated in the Texas debacle of the mid-1980s, when the collapse of the energy sector triggered widespread difficulties in others.

All industries with principally local markets were adversely affected, including retail, services, and real estate. As a consequence, even banks with modest direct exposure to the energy sector were vulnerable to the oil price shock.

Banks with a national lending scope can also fall victim to shared risks if their loan portfolios contain concentrations in industries that are vulnerable to the same economic shocks.

For example, a major West Coast bank's difficulties during the early and mid-1980s largely resulted from industry positions -- in real estate, agriculture, energy and shipping - that were all vulnerable to disinflation.

Although the portfolio was geographically diversified and contained no single overwhelming industry concentration, the bank was devastated.

Hidden Connections

Mindful of such dangers and responding to regulatory pressure, banks are now seeking ways to identify and manage risk covariance. The potential benefits include more-stable earnings and higher stock prices.

Covariant risks are often hidden from casual scrutiny, so the analytical approach chosen must be powerful enough to identify all significant sources of risk.

The framework must produce information that motivated tactical and strategic actions, integrating the process of making transaction decisions with the broader goals of portfolio management.

Furthermore, past relationships will not necessarily hold in the future; therefore, an effective approach must be predictive.

The major methods employed to date to assess the covariant risks embedded in a loan portfolio fall into three classes: historical correlations, economic structure analysis, and simulation-based approaches.

Each of these methods possess virtues as well as drawbacks and can provide valuable insights. But historical correlations and structure analysis are more limited.

Analyzing the Past

The historical tendency of different sectors to behave similarly can be measured with correlation analysis.

For each segment, correlation coefficients are calculated using some historically available proxy for the credit risk. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Is Your Loan Portfolio Really Diversified?
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Author Advanced search

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.