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FRM Part II · FRM Exam Part II · The Financial Stability Implications of Artificial Intelligence

A risk manager at a global bank reviews its AI supply chain and wants a measure of provider concentration across the 10 critical AI services it uses. Provider market shares for one service are: Provider A 50%, Provider B 30%, Provider C 20%. What is the Herfindahl-Hirschman Index (using percentage points) for this service, and how should it be interpreted?

The HHI is 3,800, from 2,500 plus 900 plus 400. This is well above common high-concentration thresholds, so the market is highly concentrated, meaning the bank and the wider system would be exposed to correlated failure at the dominant providers.

  1. A3,800, indicating a highly concentrated supplier marketCorrect
  2. B1,000, indicating a diversified market
  3. C3,800, indicating a diversified market because three providers exist
  4. D10,000, indicating perfect competition

Explanation

HHI = 50² + 30² + 20² = 2,500 + 900 + 400 = 3,800. Values above roughly 2,500 are conventionally treated as highly concentrated. The count of providers alone does not indicate diversification; 10,000 would mean a monopoly.

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