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April 2008 paper 2 question 6

S

ST6_aspirant

Member
Risk in a bank’s mortgage: concentration of customers in a particular geographical area in a single market sector (residential mortgages) is a type credit risk. Not sure why it is a credit risk. Is the reason for credit risk because when the property needs to be sold, property values may be lower in the entire area?
 
ST6_aspirant said:
Risk in a bank’s mortgage: concentration of customers in a particular geographical area in a single market sector (residential mortgages) is a type credit risk. Not sure why it is a credit risk. Is the reason for credit risk because when the property needs to be sold, property values may be lower in the entire area?
Click to expand...
This question is about a bank. The bank's assets are mortgages, ie the future payments from homeowners to repay their loans. So there is a credit risk because the homeowners may not be able to repay. The properties belong to the homeowners and not the bank.

Best wishes

Mark
 
I see. I then suppose that the homeowners being in a specific area is a risk because of for example natural disasters example: earthquake. Thanks for the explanation.

Earlier, I was thinking that if the homeowners fail to pay their installments, and banks had to sell the house, the risk could be from the value of houses falling in a particular area. Could this also be a concentration risk?
 
ST6_aspirant said:
I see. I then suppose that the homeowners being in a specific area is a risk because of for example natural disasters example: earthquake. Thanks for the explanation.

Earlier, I was thinking that if the homeowners fail to pay their installments, and banks had to sell the house, the risk could be from the value of houses falling in a particular area. Could this also be a concentration risk?
Click to expand...
Yes, this would be a concentration risk. I can imagine a situation where a big employer in the area closes down. That might lead to lots of defaults on the mortgages, but also falling house prices.

Best wishes

Mark
 
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