Distribution of credit-risk concentration in particular sectors of the economy, and economic capital before and during the COVID-19 pandemic

The aim of the work underpinning this paper has been to track the evolution of tail risk in banks’ NPL portfolios present under normal and worst conditions (before and during the pandemic of COVID-19), and to estimate the impact of sector concentration risk on amounts of economic capital. Results further allowed for analysis of different sectors with a view to determining which is riskiest. The study makes use of a multi-factor structural model, given that each sector is affected by a different systematic risk factor, with the assets of borrowers from the same sector thus correlated markedly, even as correlations between sectors are low. The research has in fact sought the further development of methodology proposed by Düllmann and Masschelein in 2006—in the direction of improved accuracy of economic-capital estimates, thanks to alternate means of mapping out the sectoral factor correlation matrix. The empirical analysis was based on individual data from Prudential Reporting under the National Bank of Poland, as well as market data. Results reveal an increase in tail risk through the 2015–2017 period, as followed by the onset of a decline. Where the paper’s second aim is concerned, there is found to be support for the idea that economic capital may be increased where sector concentration in the portfolio of a bank is accounted for. Tail risk is found to be concentrated in the sectors of construction and real estate, with accommodation and food services becoming more volatile during the pandemic. A channel for risk transfer between the financial and corporate sectors is thus found to exist. Thanks to the work done we have a better understanding of the impact of sectoral concentration of individual banks’ lending activities on level of risk, with the possibility of this gaining application as stress tests are conducted, and as supervisory recommendations from Poland’s Financial Supervision Authority are formulated.