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We propose a novel, stock‐return based, technique to measure three aspects of banks' sectoral concentration that feature prominently in episodes of bank risk: specialization (capturing high exposures), differentiation (capturing deviation from peer banks), and financial sector exposure (capturing direct connectedness) and show external validity for these measures. We find that both individual and systemic bank risk decrease with specialization. Differentiation is particularly and positively related to individual bank risk, whereas direct connectedness of banks is particularly and positively related to systemic bank risk. These findings inform the theoretical and policy debate on the relationship between sectoral concentration and banks' stability. [ABSTRACT FROM AUTHOR]

This paper provides evidence on the strategic lending decisions made by banks facing a negative funding shock. Using bank–firm level credit data, we show that banks reallocate credit within their loan portfolio in at least three different ways. First, banks reallocate to sectors where they have a high market share. Second, they also reallocate to sectors in which they are more specialized. Third, they reallocate credit toward low-risk firms. These reallocation effects are economically large. A standard deviation increase in sector market share, sector specialization, or firm soundness reduces the transmission of the funding shock to credit supply by 22%, 8%, and 10%, respectively. [ABSTRACT FROM AUTHOR]