Explanation:
The joint probability of default will decrease. The concentration ratio is a measure of a bank's exposure to a particular sector or group. A decrease in the concentration ratio implies that the bank is diversifying its loan portfolio, spreading its loans across a wider range of sectors or groups. This diversification reduces the bank's exposure to any single sector or group, thereby reducing the joint probability of default. The default correlation between the loans is less than 1, which means that the defaults are not perfectly correlated. Therefore, a decrease in the concentration ratio will result in a lower joint probability of default because the risk is spread across a larger number of loans, each with a lower individual probability of default.
Choice A is incorrect. The joint probability of default will not increase if the concentration ratio is decreasing and the default correlation between loans is less than 1. This is because a lower concentration ratio implies a more diversified loan portfolio, which reduces the risk of simultaneous defaults.
Choice B is incorrect. It is possible to determine the impact on the joint probability of default in this scenario. The decrease in concentration ratio and a default correlation less than 1 suggest that there would be a decrease in joint probability of default.
Choice D is incorrect. The concentration ratio does affect the joint probability of default as it measures how much risk exposure a bank has from its loan portfolio diversification. A lower concentration ratio indicates better diversification, which can reduce the likelihood of simultaneous defaults, thereby affecting the joint probability of default.
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Q.2653 What will be the most likely effect of a decreasing concentration ratio on the joint probability of default given that the default correlation between the loans is less than 1?
A
It will increase
B
It is not possible to determine
C
It will decrease
D
The concentration ratio does not affect the joint probability of default