FRM Part II · FRM Exam Part II · Credit Risk Management
A bank's corporate loan book has 40% of exposure to a single industry sector, whose borrowers' defaults are strongly driven by the same commodity price. Which risk is most directly highlighted by this exposure profile?
The profile shows sector concentration risk. Borrowers sharing a common driver such as a commodity price tend to default together, which raises default correlation and widens the tail of portfolio losses. Adding more loans in the same sector does not diversify this systematic risk away.
- ASector concentration risk, which raises correlation of defaults and portfolio loss volatilityCorrect
- BInterest rate risk on the banking book
- CSettlement risk from delivery-versus-payment failures
- DIdiosyncratic risk that diversifies away as the number of loans grows
Explanation
Borrowers exposed to the same systematic driver tend to default together, raising default correlation and the tail of the loss distribution. Adding more loans within the same sector does not remove this systematic component, so the idiosyncratic-risk option is wrong.
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