Credit Risk management within banking is continually developing. Advances in credit-scoring models have allowed banks to improve their avoidance of non credit-worthy firms. Through meticulous credit evaluation, banks attempt to minimize credit-specific risk to their ideal cost of capital. However, this practice may not sufficiently reduce the total loan portfolio risk; systematic risk. To minimize the total loan portfolio risk, banks can consider diversifying its loan portfolio. Yet, research indicates that the correlations between portfolio components are often unconsidered by banks. The bank is therefore exposed to low firm specific credit risk, but may be exposed to high total portfolio credit risk if the portfolio components are highly correlated. Our thesis investigates the strategy behind loan portfolio diversification at banks. This thesis is a qualitative study about how large banks in Sweden manage their loan portfo-lios. We discuss credit risk diversification with the help of Markowitz’s Modern Portfolio Theory (1952). Furthermore, we investigate whether Swedish banks actively pursue loan port-folio diversification and what methods they use. We found that the majority of large banks in Sweden to a certain degree intuitively diversify their loan portfolio. On the other hand, we found that due to practical complexities the banks do not manage using loan portfolio diversification. Due to the size of these large banks it is assumed that loan portfolio diversification will happen naturally.
Contents
1 INTRODUCTION
1.1 BACKGROUND
1.2 PROBLEM DISCUSSION
1.3 FORMULATION OF THE PROBLEM
1.4 PURPOSE
1.5 PROBLEM DELIMITATION
2 METHOD
2.1 CHOICE OF METHOD
2.1.1Qualitative Method
2.1.2 Descriptive research
2.1.3 Inductive research and Deductive research
2.2 GATHERING OF EMPIRICAL DATA
2.2.1 The Interviews
2.2.2 Problems with the gathering of data
2.3 VALIDITY
2.4 RELIABILITY
3 THE THEORETICAL FRAMEWORK
3.1 RISK MANAGEMENT
3.2 RISK DIVERSIFICATION
3.2 BANKS’ MANAGEMENT OF SYSTEMATIC AND UNSYSTEMATIC RISK
3.3 BANKS’ LOAN PORTFOLIO DIVERSIFICATION
3.3.1 Geographical Diversification
3.3.2 Industry
3.3.3 Size
3.3.4 Customer
3.3.5 Problems with the theoretical framework
3.3.6 Cost of loan portfolio diversification
3.4 BASEL ACCORD
3.5 SUMMARY
4. EMPIRICALLY GATHERED DATA
4.1 THE CONCEPT OF LOAN PORTFOLIO DIVERSIFICATION AT BANKS, THEIR ATTITUDE TOWARDS IT AND WHAT THEIR DIVERSIFICATION OBJECTIVES ARE
4.1.1 Bank A
4.1.2 Bank B
4.1.3 Bank C
4.1.4 Bank D
4.2 WHAT DOES THE PRACTICAL IMPLEMENTATION AND THE FOLLOW-UP OF LOAN PORTFOLIO DIVERSIFICATION LOOK LIKE?
4.2.1 Bank A
4.2.2 Bank B
4.2.3 Bank C
4.2.4 Bank D
4.3 HOW DO THE BANKS MANAGE THE SYSTEMATIC RISKS OF THE LOAN PORTFOLIO?
4.3.1 Bank A
4.3.2 Bank B
4.3.3 Bank C
4.3.4 Bank D
4.4 GEOGRAPHICAL DIVERSIFICATION
4.4.1 Bank A
4.4.2 Bank B
4.4.3 Bank C
4.4.4 Bank D
4.5 DIVERSIFICATION ACROSS INDUSTRIES
4.5.1 Bank A
4.5.2 Bank B
4.5.3 Bank C
4.5.4 Bank D
4.6 CUSTOMER DIVERSIFICATION
4.6.1 Bank A
4.6.2 Bank B
4.6.3 Bank C
4.6.4 Bank D
4.7 FURTHER THINGS THE BANKS WISHED TO ADD TO THE TOPIC OF LOAN PORTFOLIO DIVERSIFICATIO
4.6.1 Bank A
4.6.2 Bank C
5 ANALYSES OF THE EMPIRICAL DATA
5.2 WHAT DOES THE PRACTICAL IMPLEMENTATION AND THE FOLLOW-UP OF LOAN PORTFOLIO DIVERSIFICATION LOOK LIKE?
5.3 HOW DO THE BANKS MANAGE THE SYSTEMATIC RISKS OF THE LOAN PORTFOLIO?
5.4 GEOGRAPHICAL DIVERSIFICATION
5.5 DIVERSIFICATION ACROSS INDUSTRIES
5.6 CUSTOMER DIVERSIFICATION
6 CONCLUSIONS
6.1 CONCLUSIONS
6.2 FUTURE RESEARCH
LIST OF REFERENCES
APPENDIXES
APPENDIX 1
APPENDIX 2
APPENDIX 3
APPENDIX 4
Author: Dionne, Curtis,David, Csongor
Source: Goteborg University
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