E. Credit Concentration Risk

C 52/2017 STA Effective from 1/4/2021

78. Section V.D of the ICAAP Standard requires banks to address weaknesses at the portfolio level including credit concentrations risk. Credit concentration risk is the incremental credit loss in a portfolio of credit exposures, caused by high correlation between the credit risk drivers of those exposures. Such concentration risk arises mostly due to high correlations and dependencies between individual obligors (name concentration) or between economic sectors (sectoral concentration). Credit concentration risk can affect a bank’s health or core operations, liquidity, earnings and capital ratios. The Central Bank considers concentration risk as a key material Pillar 2 risk for all UAE banks.

79. Consequently, credit concentration arises when large exposures are associated with a small number of obligors or a small number of sectors, but not only. Credit concentration risk can arise from a seemingly granular portfolio but with high correlation between the obligors’ risk drivers.

80. In accordance with the Central Bank re Large Exposures - Credit Concentrations Limits (Notice No.226/2018), an exposure is deemed large if it accounts for more than 10% of a bank’s capital. Such threshold has been implemented for regulatory purposes. The measurement of concentration risk for risk management purposes and for determining Pillar 2 risk capital requirements should refer to the wider definition of concentration risk. Each bank is exposed to a degree of concentration risk, even when complying with the Large Exposure Regulation.

81. Each bank should perform a detailed risk analysis specific to the Real Estate exposures (RE) of the bank and the Central Bank re Standards for Real Estate Exposures (Notice No. 5733/2021).

82. Credit concentration risk is a common feature of UAE banks, but currently the Central Bank regulations for banks do not include an explicit Pillar 1 capital requirement for name and sector concentration risk. Credit concentration risk is a key prudential risk for which the capital requirement is at the discretion of banks, and it should be held under Pillar 2. This risk should warrant particular attention from each bank. In particular:

(i)	For the purpose of risk management, each bank should ensure that credit concentration risk is pro-actively and efficiently addressed. Each bank should develop policies and procedures for the identification, measurement, monitoring, and reporting of credit concentration risk. Credit concentration risk arises from exposures to obligors structured as conglomerates. Therefore each bank should have a mechanism in place to identify and aggregate exposures across related entities based on their legal relationships. Data should be aggregated across systems operated by different business units or entities. This should be indicated through the bank’s management information system (MIS);
(ii)	For the purpose of estimating the Pillar 2 capital associated with credit concentration risk, each bank should build upon the methodologies employed for risk management. These methods should be developed further, as deemed appropriate, in order to fully measure the additional capital. Each bank should compare several methodologies and propose a choice based on clear and documented justification. At a minimum, each bank should calculate and report the additional capital using the Herfindahl-Hirschman Index (HHI) methodology; and
(iii)	For the purpose of capital planning, each bank should ensure that concentration risk is taken into account adequately within its ICAAP. Each bank should assess the amount of capital, which it consider adequate to hold given the level of concentration risk in their portfolios and given their business plan and the expected economic environment.