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Analyzing Loan Portfolio Risk
A commercial bank is evaluating two lending strategies. Strategy 1 involves lending its entire capital of $100 million to a single large-scale construction project. Strategy 2 involves lending the same $100 million in the form of 1,000 separate $100,000 loans to various small businesses operating in different industries (e.g., retail, technology, food service). From a risk management perspective, explain why one of these strategies is considered safer for the bank's financial stability.
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Consider two banks, Bank A and Bank B, each with $50 million in capital available for lending. Bank A lends the entire $50 million to a single, large corporation that is building a new factory. Bank B lends its $50 million by making 500 separate loans of $100,000 each to a wide variety of small businesses in different sectors of the economy. From a risk management perspective, which statement most accurately assesses the financial stability of the two banks?
Loan Portfolio Risk Analysis
Analyzing Loan Portfolio Risk
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Analyze the following descriptions of different bank loan portfolios. Match each portfolio to the most appropriate description of its default risk level and the rationale behind it.
A bank can minimize the potential for significant financial loss if one borrower fails to repay their loan by spreading its lending activities across a wide range of different borrowers and industries. This risk management strategy is known as ________.
A new bank is building its loan portfolio. Arrange the following portfolio structures in the correct order, from the one that represents the HIGHEST risk of catastrophic loss from loan defaults to the one that represents the LOWEST risk.
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