Measuring the Sectoral Distribution of Lending to Irish

Non-Financial Corporates
by Rory McElligott and Rebecca Stuart1

ABSTRACT
There has been a rapid increase in lending to the Irish Non-Financial Corporate (NFC) sector in recent times accompanied by a
significant shift in the sectoral distribution of lending. At first glance, the effect of this appears to have been to increase the
concentration of the NFC loan portfolio. However, there are a number of measures of concentration and it is possible that different
measures would yield different results. In the first part of this paper we use a number of measures of concentration to determine
whether Irish banks’ loan portfolios have become more or less concentrated in recent times. Two distinct groups of concentration
measures are used: traditional measures, such as the Hirschman-Herfindahl Index and the Gini coefficient, and distance measures,
which benchmark individual banks’ loan portfolios against proxies of the structure of the economy. Our findings reveal that, for
the most part, both the traditional and distance measures give the same results in the Irish context. Most banks in our sample
showed an increase in concentration in the NFC loan portfolio.

In the second part of this paper, we take a closer look at sectoral concentration. First, we review the literature in this area. We
find that the literature is divided on whether concentration or diversification is the best strategy for banks. Historical experience
shows that concentration of credit risk in asset portfolios has been one of the major causes of bank distress. However, the
monitoring costs involved in operating in distinct areas and the sectoral expertise gained by concentrating may make it preferable
for a bank to concentrate their lending to a small number of sectors. Secondly, we present a European comparison of the sectoral
distribution of the NFC loan book which shows that the distribution of the Irish NFC loan book is not dissimilar to the European
position. Finally, we list some possible mitigating factors that may apply specifically to the Irish NFC loan book.

1. Introduction of measures to determine whether Irish banks’ loan

portfolios have become more or less concentrated in
There has been a rapid increase in lending to the Irish
recent times. We use traditional measures of
Non-Financial Corporate (NFC) sector in recent times.
concentration, such as the Hirschman-Herfindahl Index
Lending to NFCs as a proportion of total private-sector
(HHI) and the Gini coefficient, and distance measures,
credit increased to almost 40 per cent in June 2006
which benchmark individual banks’ loan portfolios
compared with approximately 30 per cent in 2000.
against proxies for the structure of the economy in
Indeed, in 2007Q2 the annual growth rate in lending to
Ireland. These two sets of measures have different
the NFC sector was in excess of 30 per cent. Alongside
underlying assumptions about what a diversified loan
this rapid growth, there have been significant shifts in the
portfolio looks like. The first group, traditional measures,
sectoral distribution of lending. The proportion of
assume that perfect diversification2 should mean equal
lending accounted for by certain sectors has changed
exposure by the lender to every sector, whereas the
substantially over this time period. In particular, the second group, distance measures, allow one to use a
property-related sector (consisting of the Construction predefined benchmark — such as the economic structure
and Real Estate sectors) accounted for almost 67 per — as an indicator of diversification.
cent of NFC lending by June 2007, a marked increase
from 2000 when it accounted for less than 35 per cent. Our findings from this part of the analysis reveal that, for
the most part, both the traditional and distance measures
Given this recent increase in the level of NFC lending, it give the same results in the Irish context. Most banks in
is an opportune time to examine the structure of the loan our sample showed an increase in concentration in the
book and, in particular, changes in the level of NFC loan portfolio.
concentration. However, different measures of
concentration may give different answers to this Having examined the overall trend in concentration over
question. In the first part of this paper, we use a number recent years, in the second part of this paper we examine
1
The authors are, respectively, economists in the Statistics Department and the Monetary Policy & Financial Stability Department. The views expressed
in this paper are the personal responsibility of the authors and are not necessarily those held by the Central Bank & Financial Services Authority of
Ireland or by the ESCB. The authors would like to thank their colleagues within the CBFSAI for their assistance in completing this paper.
2
Throughout the literature in this area ‘diversification’ is used simply as the opposite of ‘concentrated’, and does not carry the connotation, as it does
in finance literature, of reducing the risk of a portfolio by taking into account the degree to which the return on assets in a portfolio can be expected
to move together. We follow this example, using ‘diversification’ merely in the sense of being ‘unconcentrated’.

Financial Stability Report 2007 115

sectoral trends more closely. Firstly, the economic
literature is divided on which of two competing
hypotheses of concentration or diversification is the best
strategy for banks. Historical experience shows that
concentration of credit risk in asset portfolios has been
one of the major causes of bank distress. This is true for
individual institutions as well as for banking systems as a
whole. In a sector-concentrated loan portfolio, the bank
is lending to a portfolio of corporations that operate in
the same sector and thus are likely to be facing similar
operating conditions. The implication for banks is that
the performance (or non-performance) of the loans in its
portfolio will tend to be highly correlated. In the face of
negative economic conditions in a specific sector, the
bank would face declining asset quality in a large share
of its loan book. However, there is a second hypothesis
in the literature which suggests an alternative view on
the link between concentration and financial stability.
The monitoring costs involved in operating in distinct
areas may make it preferable for a bank to concentrate
its lending on a small number of sectors. This
concentration of sectoral expertise may improve the
bank’s credit risk decisions.
Secondly, we present an international comparison of the
sectoral distribution of the NFC loan book. The data
have not previously been available on a cross-country
basis. The data in this section benchmarks the Irish
sectoral distribution against that of some of our
European counterparts and shows that the distribution of
the Irish NFC loan book is not dissimilar to the European
position.
Finally, we list some possible mitigating factors that may
apply specifically to the Irish NFC loan book, including
within-sector dispersion that may reduce the correlation
of loan performance; the higher likelihood of loans being
collateralised in the largest sectors; and narrowed scope
of the data in dealing only with the NFC portion of the
loan book.
2. Data
We employ a bank-level dataset collected by the Central
Bank & Financial Services Authority of Ireland on a
quarterly basis. All credit institutions resident in Ireland
are required to report lending to Irish residents
categorised by economic activity of the borrower. The
aggregated sectoral data are published in Table C8 of
the CBFSAI Quarterly Bulletin and a commentary on the
sectoral developments is published in the quarterly
‘‘Sectoral Developments in Private-Sector Credit’’. The
data are separated into fifteen sub-sectors including the
116 Financial Stability Report 2007
personal sector, NFCs and other financial intermediaries.
Our study is confined to the non-financial corporate
sector. The eleven NFC sub-sectors are listed in Table 1
of the Annex. It is on the concentration of banks’
lending to these eleven NFC sub-sectors that this paper
focuses.
Although our dataset covers all resident banks in Ireland,
we restrict our analysis to banks whose business is
primarily orientated towards the Irish economy. The
inclusion of banks whose business is internationally
focused would bias the results, as their domestic loan
book may not be a true representation of their
diversification policy. This potential bias would be
particularly strong in Ireland given the importance of the
international financial services sector. We also adjust the
panel for mergers and splits in the banking population.
For example, if one bank splits into two or more banks
during the study period, we combine the new and old
banks and treat them as though they were a single bank
throughout the study period. A list of the thirteen banks
covered in the study is included in Table 2 of the Annex.
The dataset covers the period from February 1999 to
June 2007 and this provides 34 observations across time
for each bank. Our sample of banks covers on average
93 per cent of the total stock of loans to the NFC sector
in each quarter. This coverage has increased over time
from 85 per cent in February 1999 to 97 per cent in
June 2007.
Chart 1: Aggregate Concentration Measures
0.7 0.35
Gini (LHS) HHI (RHS)
0.6 0.30
0.5 0.25
0.4 0.20
0.3 0.15
0.2 0.10
1999 00 01 02 03 04 05 06 07
Feb June
Source: CBFSAI, Authors' calculations
3. Lending to NFCs
Prior to investigating changes in individual banks’
sectoral lending trends, it is useful to first look at
developments in the total banking sector over the
period. The sectoral distribution of loans to Irish NFCs
has changed considerably over the study period. The
concentration level as measured by the Hirschman-
Herfindahl Index (HHI) has increased since February
1999 from a level of 0.134 to 0.301 in June 2007. The
Gini coefficient also shows a change in the structure of
the aggregate loan portfolio towards a more
concentrated portfolio. As shown in Chart 1,
concentration increased slowly up to mid-2002, after
which the pace of increase accelerated.
The data in Chart 2 facilitate a more detailed analysis of
the change in the sectoral distribution of loans to the
NFC sector over the study period. In 1999 there was a
relatively balanced loan book with significant exposure
to a number of sectors including Manufacturing, Real
Estate, Agriculture and Forestry and Wholesale/Retail
Trade and Repairs. It is clear from the 2007 data that
banks’ exposure to the Real Estate sector has grown
hugely in the eight-year period. In February 1999, the
Real Estate sector accounted for 15 per cent of the
outstanding stock and this was the second largest sector
after Manufacturing, which comprised 19 per cent of the
Chart 2: Sectoral Distribution of Advances, February 1999 & June 2007
February 1999
1% 1%
6%
15%
13%
9%
9%
15%
19%
12%
Source: CBFSAI, Authors' calculations
Note: 'Other' combines Fishing with Mining and Quarrying, which individually represent less than 1 per cent of total advances in both 1999 and
2007.
loan book. By June 2007 Manufacturing had declined to
just 6 per cent of the loan book and Real Estate
dominated the NFC loan book of Irish banks with 50
per cent of total loans. Alongside Real Estate, only the
Construction sector increased its share of the loan book
in the time period. The Real Estate and Construction
sectors — including the residential real estate sector, the
commercial real estate sector, property companies
investing overseas, and infrastructure construction
companies — are closely related and now account for a
combined 67 per cent of all loans by Irish banks to Irish
NFCs (against 24 per cent in February 1999). All other
sectors now account for a proportionately lower level of
the banking book than in early-1999 with the main losers
being Manufacturing, detailed above, Agriculture and
Forestry (13 per cent to 3 per cent) and Wholesale/Retail
Trade and Repairs (15 per cent to 8 per cent).
Table 1 presents data on the stock of loans and growth
rates for each sector from February 1999 to June 2007.
The total stock of loans to Irish NFCs increased from
\22.75 billion in 1999 to \142.98 billion in 2007, an
increase of 528 per cent. The Real Estate sector
accounted for 57 per cent of the total NFC increase,
growing by just under 1,900 per cent since 1999.
Manufacturing and Agriculture and Forestry recorded
the slowest rate of increase in the period at just 80 and
63 per cent, respectively.
June 2007
1% 1%
2%
3%
5%
Real Estate 6%
Construction
Wholesale/Retail
Trade & Repairs 7%
Hotels & Restaurants
50%
Manufacturing
Business
8%
Agriculture
Transport, Storage &
Communications
Electricity, Gas & Water
Supply 17%
Other
Financial Stability Report 2007 117
Table 1: Sectoral Breakdown of NFC Loans, 1999 and 2007

Stock (\ million) Change

1999 2007 \ million per cent

Agriculture & Forestry 2,888 4,702 1,814 62.8

Fishing 111 406 295 265.8
Mining & Quarrying 196 447 251 128.1
Manufacturing 4,498 8,095 3,597 80.0
Electricity, Gas & Water Supply 281 1,127 846 301.1
Construction 1,962 24,351 22,389 1,141.1
Wholesale/Retail Trade & Repairs 3,331 12,103 8,772 263.3
Hotels & Restaurants 2,677 10,537 7,860 293.6
Transport, Storage & Communications 1,273 2,939 1,666 130.9
Real Estate 3,594 71,833 68,239 1,898.7
Services 1,946 6,437 4,491 230.8

NFC Total 22,757 142,977 120,220 528.3

4. Concentration Measures is segment i’s share of bank b’s total NFC lending
Having reviewed the data and presented graphical portfolio. Let yit denote the share of loan segment i in the
evidence suggesting an increasing sectoral benchmark loan portfolio NFC loans.
concentration in the aggregate Irish loan book, we now a) The traditional measures of dispersion are the
turn to statistical measures of concentration, and their Hirschman-Herfindahl Index and the Gini coefficient.
evolution over time. In this section we outline a number n

of concentration levels, while in Section 5 we analyse i) Hirschman-Herfindahl Index (HHI) HHI(x) =  (xi)2
i=1
the developments in these measures in recent years. n

 (2j − n − 1)Xi
b,t
ii) Gini coefficient
G=
j=1
4.1 Traditional and Distance Measures ,
2n2

Concentration measures can be separated into two
where n is the number of values observed, j is the rank
distinct classes: traditional measures and distance
of values in ascending order and
is the average of
measures. The implicit assumption in traditional
the observed euro values of exposure, Xb,i t.
measures is that a perfectly diversified3 loan book should
have equal exposures to all sectors of the economy. A low value in the above measures means a low level of
However, true diversification is unlikely to require an concentration (the individual exposure of the bank to the
equal weighting of all sectors, but a weighting that is different sectors is low), and a high value means a high
similar to the relative size of each economic sector in level of concentration. The HHI values range from a
the overall economy. Distance measures attempt to minimum of n1 to a maximum of 1. The Gini coefficient
overcome the assumption of equal weighting by values range from a minimum of 0 to a maximum of
measuring the distance of a bank loan portfolio from a (n−1)
. The HHI and Gini coefficient are widely used
n
predefined benchmark portfolio that captures the measures of market concentration.
relative size of different sectors. Details of the measures
utilized in our study are presented below. We use two b) The five distance measures are:
traditional measures of concentration and five distance DM1: Maximum Absolute Difference
measures.
D1(x, y) = max x1 − y1
i

For all measures, we represent bank exposures in the

DM2: Normalised Sum of Absolute Differences
following way: let Xb,i t be the euro value of exposure of
Xb,t 1
n

bank b at time t to loan segment i. Then xb,i t = n i b,t D2(x, y) =  xi − yi
j=1 Xj 2 i=1

3
As noted above, we use ‘diversification’ in the same sense as it is used throughout the literature in this area: simply as the opposite of ‘concentrated’.
In this sense, it does not carry the connotation, as it does in finance literature, of reducing the risk of a portfolio by taking into account the degree
to which the return on assets in a portfolio can be expected to move together.

118 Financial Stability Report 2007

 DM3: Normalised Sum of Squared Differences
n
1 in the overall economy, take account of this kind of
D3(x, y) =  xi − yi
2
2 i=1
DM4: Average Relative Difference
1 xi − yi
n
D4(x, y) =  x +y
n i=1 i i
DM5: Average Squared Relative Difference


2
x − yi
n
1 unclear which measure of risk best captures loan
D5(x, y) =  i
n i = 1 xi + yi
All the above distance measures are normalised to the
interval [0,1] and the higher the level the higher the
concentration. The first distance measure D1 simply
reports the distance of the sector in the loan portfolio
which is the furthest from the benchmark for that sector.
This measure is therefore insensitive to all but this one
sector and may not pick up significant changes in
concentration. D2 is the normalised average of the
absolute difference across all sectors. The result should
be read as the proportion of a bank’s loan portfolio that
must be rearranged to achieve the benchmark portfolio
structure. Measure D3 is similar but assigns a higher
weight to sectors with a large deviation from the
benchmark. Measures D4 and D5 are based on the
relative difference of a loan portfolio and the benchmark
portfolio. These two measures have the property that the
deviation from the benchmark is seen relative to the size
of the sector. This has the effect of giving a lower weight
to a 1 per cent divergence in a sector representing 90
per cent of the market than a 1 per cent deviation in a
sector representing just a 10 per cent share. It is worth
noting a disadvantage of the latter two methods — when
a sector is not present in a bank lending portfolio (e.g.,
x1 = 0) it will still contribute n1 towards the distance
measure.
4.2 Distance Measures in Other Studies
Two previous studies have used distance measures over
traditional measures of concentration. Kamp, Pfingsten
and Porath (2005), carried out a similar study, using data
on 2,231 individual German banks’ loan books to
estimate loan portfolio concentration over the period
1993 to 2002. They argue that the benefit of distance
measures over traditional measures, such as the HHI,
arises from their ability to take account of size difference
in each sector. For instance, if a bank has a similar
nominal exposure to two sectors — one a relatively big
sector within the economy, and one a relatively small
sector — the bank’s loan book might be said to be very
specialised in the smaller sector. Such specialisation will
not be picked up by a HHI which weights each sector
4
The four categories are: commercial banks, banks under public law, cooperative and other banks.
equally. However, as argued by Kamp et al, distance
measures, which weight industries by their importance
specialisation, providing a more accurate picture. In the
second study, Pfingsten and Rudolph (2002) used data
on four categories4 of banks to estimate the distance
between the loan book of each category and the total
loan book of all four categories over the period 1970 to
2001. They suggest that a benefit of distance measures
is that they abstract from any kind of risk or return
specification. They argue that this is beneficial as it is
default risk.
4.3 Benchmarks used in this Study
In our current study we wish to measure the
concentration of bank NFC lending when benchmarked
against the relative size of each sector in the economy.
We have a number of benchmarks or proxies for each
sector’s share of the Irish economy available to us.
The first benchmark we use is employment by sector.
These data are available on a quarterly basis in the
Quarterly National Household Survey compiled by the
Central Statistics Office. A breakdown is available by
NACE sector and is, therefore, directly comparable to
the sectoral classification used in the lending data. Other
advantages of these data are its availability on the same
timescale and frequency as the bank-level data. Though
we believe that employment figures are a good proxy
for economy structure, it is possible that there may be
some sectors that are not labour intensive but provide a
high value-added component to the economy.
Our second benchmark is each sector’s contribution to
the Gross Value Added (GVA) of the economy. The use
of this benchmark along with the employment
benchmark presented above is that it overcomes the
main risk of the employment benchmark of giving too
high a weight to labour-intensive industries. The major
drawback with the GVA benchmark is the annual, rather
than quarterly, nature of the observations, and the time
lag in the release of the data. These data are available
on an annual basis with the latest data relating to 2005.
To address the problem of lack of observations we
‘quarterise’ the data using the Denton estimation
method to produce quarterly sectoral GVA figures.
The third benchmark is each sector’s share of the total
NFC lending portfolio for all banks in Ireland. This is the
most widely used benchmark in previous studies (Kamp
et al (2005) and Pfingsten et al (2002)). Like the data for
the employment figures benchmark, these data have the
advantage of being on the same timescale and frequency
as the bank-level data. A major drawback with this
benchmark is that it is endogenous: it is the sum of the
Financial Stability Report 2007 119
individual bank lending portfolios and its movement is,
therefore, a function of the individual banks’ lending
decisions. We believe that due to the small size of the
banks in Ireland such a benchmark would be unsuitable
and we therefore concentrate on the first two
benchmarks where more robust results should be found.
5. Results
Section 3 presented graphical evidence of the changing
distribution and concentration of the NFC loan book in
recent years. In this section the focus is on the trend in
individual banks’ loan books over the same time period.
Specifically, we use the concentration measures outlined
in Section 4 to examine whether statistical techniques
show that loan books are becoming more concentrated
over time. In their study of German banks, Kamp et al
(2005) find that some distance measures gave conflicting
results on concentration and it is not clear which
measure should be selected. Due to these findings, we
will present our results for all measures rather than select
a single measure at the outset.
5.1 Summary Statistics
Summary statistics for both the traditional and distance
measures are provided in Table 2a. For the traditional
measures, the closer to 1 that they are, the more
concentrated the loan book. Therefore, any increase in
the traditional measures indicates an increase in
concentration. Table 2a shows that there has been an
increase in the average HHI and Gini coefficient over
the period of analysis. As the distance measures show
the distance between the individual loan books and the
benchmarks, the closer to 1 that the distance measures
are, the greater the difference between each individual
bank’s loan book and economy structure. A decrease in
the average distance measure indicates that banks’
lending behaviour more closely reflects the structure of
the economy as a whole. Table 2a shows the distance
measures using employment in each sector as a
benchmark. It is clear from Table 2a that all measures
suggest the banking system’s NFC loan portfolio has
been moving away from the economy structure in recent
years. Using the other benchmark — Gross Value Added
— similar results are obtained. Pair-wise correlation
coefficients presented in Table 2b show that there is a
strong significant correlation between the distance
measures using the same sectoral employment
benchmark. However, while the correlation between the
distance measures is strong, it is not perfect, and we
therefore present results for all the measures in the
analysis below.

Table 2a: Summary Statistics: Concentration Averages, 1999-2006

HHI Gini DM1 DM2 DM3 DM4 DM5

Feb ’99 0.276 0.595 0.300 0.443 0.104 0.537 0.412

Dec ’99 0.257 0.586 0.290 0.447 0.095 0.530 0.403
Dec ’00 0.254 0.584 0.289 0.455 0.094 0.532 0.400
Dec ’01 0.285 0.605 0.366 0.484 0.120 0.519 0.389
Dec ’02 0.282 0.611 0.369 0.483 0.118 0.516 0.382
Dec ’03 0.287 0.629 0.409 0.501 0.130 0.543 0.413
Dec ’04 0.309 0.641 0.428 0.513 0.140 0.561 0.423
Dec ’05 0.323 0.650 0.456 0.522 0.149 0.558 0.422
Dec ’06 0.359 0.674 0.493 0.559 0.172 0.578 0.443

Note: ‘DM’ denotes distance measure.

Table 2b: Summary Statistics: Distance Measure Correlation Coefficients

Measure 1 Measure 2 Measure 3 Measure 4 Measure 5

Measure 1 1
Measure 2 0.9978 1
(0.000)
Measure 3 0.9936 0.991 1
(0.000) (0.000)
Measure 4 0.9543 0.9595 0.9639 1
(0.000) (0.000) (0.000)
Measure 5 0.9541 0.9535 0.9769 0.9839 1
(0.000) (0.000) (0.000) (0.000)

Note: Significance test p-values are in brackets.

120 Financial Stability Report 2007

5.2 Empirical Results
Regression analysis is used to estimate the change in the
sectoral make-up of banks’ loan portfolios over time.
First, a fixed-effect panel regression is run to estimate
the time trend in each of the measures.5 The estimates
obtained from this model provide the average behaviour
of all the banks in the sample. Second, individual
regressions are run for each bank.6 This provides
estimates of the behaviour of individual banks. This
analysis is first carried out on the distance measures. The
traditional measures of diversification (HHI and Gini
coefficient) are then used to cross-check the results.
5.2.1 Distance Measures using Employment Figures
Benchmark
The results from the analysis using employment by sector
as a benchmark are presented in Table 3. The panel
analysis results are positive and significant for all of the
distance measures, implying that the ‘distance’ between
the benchmark and banks’ loan portfolios is increasing.
As the distance measures take the benchmark — in this
instance employment by sector — as the level of perfect
diversification, significant positive results such as these
imply that, on the whole, banks’ NFC loan books have
become more concentrated over the period of
analysis.
The bank-level regression analysis shows that the panel
estimates are not being driven by a small number of
banks. With the exception of DM5, the majority of banks
have significant positive results for all measures. These
results support the conclusion, drawn from the panel
estimates, that banks’ loan portfolios are becoming
more concentrated.
The bank-level results also show that a number of banks
for each measure have significant negative results,
suggesting these banks’ lending behaviour is moving
closer to the benchmark — i.e., becoming less
concentrated. However, these results are largely from
banks that would have had a very concentrated loan
book at the start of the period of analysis. The results
are, therefore, likely to have resulted from their shifting
into new sectors over the period of analysis.
5.2.2 Distance Measures using GVA Benchmark
GVA (Gross Value Added) by sector is the second proxy
for the economy structure used as a benchmark. The
panel data estimates for the GVA benchmark show
significant positive results for all distance measures7.
These results correspond with those for the employment
by sector benchmark in showing a movement towards
more concentrated loan portfolios.

Table 3: Empirical Results for Employment Benchmark Distance Measures

DM1 DM2 DM3 DM4 DM5

Panel estimates

Panel Coefficeint 0.00678 0.00342 0.00248 0.00181 0.00157

P-value 0.000 0.000 0.000 0.000 0.000

Bank-level regressions

No. banks with trend

Significant @ 5% level
Diversifying
Significant @ 10% level
No Change
Significant @ 10% level
Concentrating
Significant @ 5% level
1 2 2 3 3
— — 1 1 —
2 1 — 2 4
— — — — —
10 10 10 7 6

Note: ‘DM’ denotes distance measure.

5
Each measure of diversification is regressed on a linear trend variable:
DMtb =  + .time + tb,
where DMtb is the diversification measure of bank b at time t.
6
The trend model used is:
DMtb = b + b.time + tb.
7
DM3 is significant at the 10 per cent level.

Financial Stability Report 2007 121

Table 4: Empirical Results for GVA Benchmark Distance Measures

DM1 DM2 DM3 DM4 DM5

Panel estimates

Panel Coefficeint 0.00174 0.00132 0.00047 0.00150 0.00070

P-value 0.000 0.002 0.075 0.000 0.020

Bank-level regressions

No. banks with trend

Significant @ 5% level 3 3 3 3 4
Diversifying
Significant @ 10% level — — — — —
No Change 3 3 3 2 2
Significant @ 10% level 2 — — 1 —
Concentrating
Significant @ 5% level 10 7 7 7 7

Note: ‘DM’ denotes distance measure.

In the bank-level regressions the majority of banks have
significantly positive results. Again, this is similar to the
results from the employment-by-sector benchmark, and
indicates increased concentration in the loan portfolios
of most banks. For each measure, there are also a
number of banks that have significantly negative results.
As above, these are largely banks that had highly
concentrated loan portfolios at the start of the sample
period. The movement of these banks from a very small
number of sectors, into a somewhat wider variety, would
account for these results. The final point of note arising
from these results is that a larger number of banks have
insignificant results than for the employment benchmark.
It is felt this is largely due to drawbacks in the data,
specifically the annual nature of the data and the need
to ‘quarterise’ it, as detailed in Section 4.3.
5.2.3 Traditional Measures
Traditional measures are used to cross-check the results
from the distance measures above. The results for the
traditional measures are indeed in line with the findings
for the distance measures. Table 2a has already shown
that the mean of both traditional measures appear to
have increased over time. This is borne out by a more
formal regression analysis results presented in Table 5.
The panel estimation shows that there was a significant
positive trend in both traditional measures over time.
Similarly, the bank-level regressions show that the
majority of banks’ loan books have significant positive
results over time. Only two banks show reduced
concentration. These are, again, banks with very
concentrated loan portfolios at the beginning of the
period of analysis.

Table 5: Empirical Results for Traditional Measures

HHI Gini Coefficient

Panel estimates

Panel Trend 0.00349 0.00292

P-value 0.000 0.000

Bank-level regressions

No. banks with trend

Significant @ 5% level
Diversifying
Significant @ 10% level
No Change
Significant @ 10% level
Concentrating
Significant @ 5% level
1 1
1 1
— 1
— —
11 10

122 Financial Stability Report 2007

6. A Closer Examination of Sectoral
Concentration
So far, the focus of this paper has been on using various
measures of concentration to determine the trend in the
distribution of the loan book in recent years. In this part
of the paper, we explore a number of pros and cons
associated with sectoral concentration in loan books in
general and in the Irish case in particular. In dealing with
sectoral concentration in particular, we review existing
literature in this area which shows that there are benefits
associated with both diversified and concentrated loan
books. For Ireland in particular, we use new international
data to benchmark the sectoral distribution of the Irish
loan book against our European counterparts, and we
also present some possible factors that may mitigate risks
associated with a concentrated NFC loan book in the
Irish context.
6.1 Literature on Sectoral Concentration
A survey of the existing literature in this area shows that
a tension exists with regard to whether it is in the best
interests of banks to hold a concentrated or a
‘diversified’ loan book. On the one hand, diversification
should reduce the risk of financial losses as the bank’s
portfolio encompasses projects across a number of
unrelated sectors [Diamond (1984)]. On the other hand,
the monitoring costs associated with lending to a
number of sectors may make it cheaper to maintain a
more concentrated loan book [Stomper (2004)].
Winton (1999) uses a theoretical model to analyse the
trade-off between the benefits of close monitoring and
the risks arising from a high level of concentration. It
appears that holding a diversified loan book is the best
strategy when loans have moderate exposure to sector
downturns. When downside risks are high, monitoring is
important, and diversification, by reducing the ability of
banks to monitor, has a negative effect on bank
performance. This implies that monitoring costs have an
impact on the credit risk of loan portfolios.
Further evidence of the impact of monitoring costs on
a diversified loan book arises from the ‘winner’s curse’
problem whereby banks experience higher monitoring
costs in sectors that they have newly entered. Winton
(1999) finds some evidence of this, and further
theoretical evidence is provided by Dell’Ariccia (2001),
Dell’Ariccia et al (1999), Gehrig (1998) and Marquez
(1997). Schaffer (1998) finds supporting empirical
evidence.
Acharya et al (2002) use data on 105 Italian banks to
test a number of hypotheses put forward by Winton.
Results from Acharya et al are broadly in line with
Winton, finding that bank returns in general, measured
by a number of indicators, are decreased by a diversified
loan book, most particularly when risk (and therefore
monitoring costs) are high. Acharya et al conclude that
diversification is not a guarantee of superior
performance or greater bank safety. The effects of
concentration on United States financial services firms
are studied by Elyasiani and Deng (2007). They analyse
sectoral, geographical and activity diversification. It is
found that all types of diversification lead to decreasing
returns as well as decreasing income. Elyasiani and Deng
find that this relationship is stronger the harder it is for
banks to monitor their loans. Overall, they suggest that
banks trade off returns for reduced risks.
On the other hand, if a bank’s loan book is concentrated
in a specific sector, or a number of highly correlated
sectors, then a shock affecting debtors’ ability to repay
their loans may cause the bank financial distress. In such
a situation, banks must hold enough capital to allow for
the sectoral concentration of their loan books. Düllman
and Masschelein (2006) estimate the effect of sector
concentration on economic capital using a sample of
German banks. They find that, in comparison with a
benchmark portfolio reflecting the concentration of the
aggregate loan book of German banks, the sector
concentration observed in certain individual banks can
increase economic capital by 37 to 50 per cent. For the
United States, Heitfield et al (2005) simulate the
distribution credit losses for real syndicated loan
portfolios. They find that sector concentration risk is the
main contributor to economic capital for all portfolios.
6.2 International Comparison of Lending to NFCs
Placing the sectoral distribution of Irish NFC lending in
an international context also allows us to benchmark the
sectoral distribution against some of our European
counterparts. Cross-country sectoral distribution data
have not previously been available on a cross-country
basis, and is still not available for all European countries.
However, for the data available, our international
comparison shows that the structure of the Irish NFC
loan book is not dissimilar from our European
counterparts.
To facilitate cross-country comparison we combine
the following sectors: Agriculture and Forestry with
Fishing, and Mining and Quarrying with Manufacturing.
Also, in the Irish data above, the NACE sector Real
Estate Renting and Business Activities is separated
into Real Estate Activities and Services. It is not possible
Financial Stability Report 2007 123
to make this separation for the other national data
and, therefore, we present the combined sectors in
Chart 3.
Chart 3: Sectoral Distribution of Advances
Comparison, end-2006
GR IT EA5 EA5 PT SP UK IE DE
(Weighted) (Ave)
Real Estate & Other Business Activities Construction
Wholesale/Retail Trade & Repairs Hotels & Restaurants
Manufacturing, Mining & Quarrying Agriculture, Fishing & Forestry
Transport, Storage & Communications Electricity, Gas & Water Supply
Source: Bank of Greece, Banca D’Italia, Banco de Portugal,
Banco de Espana, Bank of England, CBFSAI, Deutsche
Bundesbank, The Central Bank of Malta, Sveriges Riksbank,
Authors’ calculations
Note: 'EA 5 (Weighted)' and 'EA 5(Ave)' refer to the weighted
and simple average of the 5 euro area countries on the chart
respectively.
We present the data for 9 European countries (6 euro
area, including Ireland) where data are available in Chart
3. Using the five other euro area countries (Germany,
Italy, Portugal, Spain and Greece) we also calculate a
euro area 5 (EA5) average sectoral distribution, both
weighted and unweighted. The unweighted data are
useful as Germany and Italy account for a very large
weight in the weighted data and hence strongly bias
the results.
With the exception of Greece, the diverse sector of Real
Estate, Renting and Business Activities is the largest in
each country. Ireland’s exposure to this category is
higher than the European average, however, it is below
that for Germany and Sweden. As mentioned above, for
the vast majority of countries it is not possible to
separate Real Estate from Services in this category.
8
See Kearns, A. and M. Woods, (2006).
124 Financial Stability Report 2007
However, we do have these data for Ireland and Real
Estate Activities accounts for 90 per cent of the
composite category. The Manufacturing/Mining and
Quarrying sector is the second largest category for the
EA5 accounting for 19 per cent of NFC lending. Of the
nine countries where data are available, Ireland has the
lowest proportion of lending to this sector at just under
per cent
100
6 per cent of total NFC lending. One potential reason
for this low level may be due to the large presence of
90
multi-national corporations which may source there
80 funding from parent companies or from non-domestic
banks.
70
60
Lending by Irish banks to the Construction sector, at 16.3
per cent of the NFC loan book, is somewhat above the
50
EA5 average at 12.9 per cent of the total NFC loan book.
40 The variation of this category is large across countries.
Banks in Spain and Portugal have the largest exposure
30
to this sector, 18.2 and 20.6 per cent, respectively.
20 Sweden (2.5 per cent), Germany (4.2 per cent) and the
10 United Kingdom (5.9 per cent) all have relatively low
exposure.
0
MT SE Despite the large decline in the importance of
Agriculture to Irish banks’ NFC loan books in recent
years (described above), the share of Agriculture is still
marginally above the euro area average. Ireland has a
higher exposure to the Hotels and Restaurants sector
than any other country with the United Kingdom having
the second largest. The EA5 Wholesale and Retail Trade
lending is proportionally much larger than in Ireland.
Ireland also has a below average exposure to the
Transport, Storage and Communications sector.
6.3 Implications in Ireland
As outlined above, sectoral concentration may have
positive or negative financial stability implications. The
high level of sector concentration may increase the
correlation between the performance (or non-
performance) of loans in the banks’ portfolio. If the
shock is large enough to lead to non-performance of
loans, then banks may find that their level of non-
performing loans is sensitive to a shock to these sectors.
Thus, in the event of a shock to the Construction and
Real Estate sectors, banks may find that the performance
of these loans might be correlated and asset quality
could deteriorate in many loans. An additional risk is that
the rates of increase in prices across different segments
of the Irish property market have tended to move
upwards and downwards over the last thirty years,
particularly during those periods of slower economic
growth.8 This includes commercial property and
residential property, which is the dominant exposure of
banks to the household sector.
However, there are several possible mitigating factors
that may limit the risks in Ireland. Firstly, there is some
within-sector dispersion that may reduce the correlation
of loan performance. For instance, the Real Estate and
Construction sectors comprise the residential real estate
sector, the commercial Real Estate sector, property
companies investing overseas, and infrastructure
construction companies. Correlation would be lowered
by construction/real estate companies borrowing to
invest abroad in markets that may be subject to a
different business cycle to the domestic market.
Infrastructure companies may encounter a positive
business climate even in the event of a slowdown in the
real estate sector. In the particular case of Ireland, a large
infrastructure spending programme in the National
Development Plan is scheduled for the coming years that
could partly guard against any decline in the other
subsectors such as residential construction.
Secondly, the Construction and Real Estate sectors
account for an increasing share of the loan book where
there may be a higher likelihood of loans being
collateralised than is perhaps the case in other sectors.
This will have the effect of acting as an increased buffer
to banks.
Finally, it should be kept in mind that our study is
confined to a section of the Irish banking system’s total
loan book — lending to Irish non-financial corporations.
We therefore exclude lending to other sectors such as
public sector, financial sector and households as well as
lending to non-Irish residents.
7. Conclusion
The recent rapid increase in credit growth to the Irish
NFC sector has been accompanied by a shift in the
sectoral distribution of lending. A comparison of the
distribution of lending in 1999 and 2006 showed that at
the aggregate level, only two sectors, Construction and
Real Estate, have increased their share of the NFC loan
portfolio over time. These gains have primarily come at
the expense of the Agriculture and Manufacturing
sectors. In the first part of this paper, we used a number
of measures of concentration to determine whether Irish
banks’ loan portfolios have become more or less
concentrated in recent times. The measures employed
fall into two distinct groups (traditional and distance
measures) that assume different theories on the ideal
structure of lending portfolios.
Our findings reveal that, for the most part, both the
traditional and distance measures give the same results
in the Irish context. Using both measures, most banks
showed an increase in concentration in the NFC loan
portfolio. Both sets of measures show a small number of
banks moving to a more diversified portfolio, however;
these shared the characteristics of beginning the period
as very specialised banks and they have realigned their
portfolios more in line with the market.
In the second part of this paper we examined a number
of pros and cons associated with the current sectoral
distribution of the Irish NFC loan book. Firstly, a review
of the existing literature in this area is divided with regard
to whether, from a financial stability perspective,
diversification or concentration is a better strategy for
banks. Secondly, when a comparison is made with other
European countries, it is found that the structure of the
Irish NFC loan portfolio is not significantly different from
that of other countries. The share of NFC loans to the
Irish Construction sector is significantly higher than in
the UK and Germany, but less than Spain and Portugal.
Ireland’s Manufacturing sector accounts for the lowest
share of any NFC loan book where data was available.
Finally, there are a number of possible mitigating factors
in the case of Irish banks: within-sector dispersion that
may reduce the correlation of loan performance, the
higher likelihood of loans being collateralised in the
largest sectors, and narrowed scope of the data in
dealing only with the NFC portion of the loan book.
References
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Financial Stability Report 2007 125
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Diamond, D., (1984), ‘‘Financial Intermediation and
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Annex
Table 1: Sub-sectors included in the Non-Financial Table 2. Banks Covered in Study
Corporate Sector
ACC Bank plc
Allied Irish Bank plc
NACE code Sub-sector
Anglo Irish Bank Corporation plc
A Agriculture & Forestry The Governor and Company of the Bank of Ireland
B Fishing Bank of Scotland (Ireland) Ltd
C Mining & Quarrying Danske Bank A/S
D Manufacturing EBS Building Society
E Electricity, Gas & Water supply First Active plc
F Construction ICS Building Society
G Wholesale/Retail Trade & Repairs IIB Bank plc
H Hotels & Restaurants Irish Nationwide Building Society
I Transport, Storage & Communications Irish Life & Permanent plc
K1 Real Estate Ulster Bank Ireland Ltd
K minus K1 Services

Financial Stability Report 2007 127