How do you measure concentration risk in a loan portfolio?

• A. Only consider geographic concentration.
• B. Assess borrower concentration, industry concentration, geography, and product mix; use dollar concentration and Herfindahl index.
• C. Use a single PD metric for all exposures.
• D. Focus only on the number of borrowers.

Answer: (B)

Concentration risk is about how heavily a loan portfolio’s exposure is tied to a few borrowers, industries, geographies, or product types. To measure it well, you look across multiple dimensions: borrower concentration, industry concentration, geography, and product mix. Then you quantify how concentrated the exposures are using two complementary tools. Dollar concentration looks at how large the top exposures are relative to total exposure, highlighting where the biggest bets lie. The Herfindahl index sums the squared shares of exposure for each category (borrowers, industries, geographies, or product types); a higher Herfindahl value means less diversification and more concentration risk.

This approach matters because concentration can arise in any dimension and the combination of large exposures in a few areas can amplify losses during stress. Relying on geographic concentration alone misses other risky focal points; using a single PD metric overlooks how concentration interacts with exposure size; and focusing only on the number of borrowers ignores how large those exposures are. By assessing multiple dimensions with both dollar concentration and the Herfindahl index, you get a fuller, more actionable view of concentration risk.