Credit Risk Concentration and Its Effect on Savings and Load

OTC derivatives broker-dealers perform measurement and limitation of credit risk not only to private counterparties, but also based on geographic regions, industry groups, and sometimes other categorizations measures. For instance, the Derivatives Policy Group in the year 1995 recommended measurement and disclosure of credit exposure risk by geographic location, industry, and credit rating. Aside from one guesses that such classifications define groups that might act in concert to take benefit of their private information, it may not be obvious that discussion of loans to a privately informed borrower why one wishes to measure limit credit risk concentration by groups. Here again, however, adverse selection can play a role. (more…)