BIF 4-6

Here are the study notes in detailed bullet points:

• Chapter 4: Loans and Credit Risk*
• Credit Risk: The risk of loss due to a borrower's failure to make payments as agreed.
• Asset Transformation: The process by which financial institutions convert deposits into loans.
• Loan Concentration Risk: The risk arising from excessive dependence on any one source of funding.
• Interest Rate (Fixed vs. Floating): Fixed-rate loans have a set interest rate throughout the loan period, while floating-rate loans' interest adjusts with market rates.
• Syndicated Loan: A loan provided by a group of lenders and structured by a lead bank.
• Secured vs. Unsecured Loan: A secured loan is backed by collateral; an unsecured loan is not, relying instead on the borrower's creditworthiness.
• Covenants: Conditions in loan agreements that limit or prescribe borrower behavior to protect the lender.
• Credit Risk Premium: An additional interest rate that lenders charge to compensate for the risk of borrower default.
• Euribor: A benchmark rate that reflects the interest rate at which euro interbank term deposits are offered within the eurozone.
• Credit Rating: An evaluation of a borrower's creditworthiness based on their history and financial condition.
• Qualitative Models: Assess credit risk using subjective analysis of borrower-specific and market-specific factors.
• Quantitative Models (Credit Scoring): Use statistical methods to predict borrower default risk based on observed characteristics.
• Linear Probability Model: A regression model that estimates the probability of default based on various borrower attributes.
  • Formula: Probability of default = Sum of (coefficients × borrower attributes)
• RAROC (Risk-Adjusted Return On Capital): A measure to assess the return on capital adjusted for the risk taken.
  • Formula: RAROC = (Expected Return - Expected Loss) / Economic Capital
• Duration and Capital at Risk: Assessing loan risk by estimating how the value of a loan changes with interest rates.
  • Formula: Change in loan value = -Duration × Loan amount × Change in interest rate / (1 + base rate)
• Loan Portfolio Diversification: Reducing risk by holding a variety of loans with different risk profiles.
• Credit Risk Concentration: The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations.
• Migration Analysis: Tracking changes in the credit quality of borrowers over time to manage concentration risk.
• Concentration Limits: Setting maximum limits on the amount of exposure to a single borrower or sector to mitigate concentration risk.
• Expected Return on a Loan: The return a lender anticipates receiving, accounting for the interest and potential for default.
  • Formula: Expected Return = Interest Rate + Credit Risk Premium - Expected Loss
• Chapter 5: Liquidity Risk and Liquidity Management*
• Liquidity Risk: The risk of being unable to meet contractual and contingent obligations due to insufficient funds.
• Liability-Side Reason: When depositors and other liability holders withdraw funds faster than anticipated.
• Asset-Side Reason: When unforeseen loan commitments are drawn, requiring immediate funding by the bank.
• Net Deposit Drains: The net result of deposit withdrawals exceeding deposit additions.
• Purchased Liquidity Management: Obtaining funds through borrowing to cover liquidity needs, such as issuing wholesale deposits or turning to the money market.
• Stored Liquidity Management: Using cash reserves or liquidating assets to meet liquidity needs.
• Minimum Reserve Requirements: The mandatory cash reserves that banks must hold with their central bank, aimed at ensuring liquidity.
• Financing Gap: The difference between a bank's average loans and its average deposits, indicating potential liquidity needs.
  • Formula: Financing Gap = Average Loans - Average Deposits
• Liquidity Risk Exposure: The degree to which a bank relies on borrowed funds to cover its financing gap and liquid asset holdings.
• Liquidity Risk Analysis: Assessing a bank's liquidity needs by comparing ratios like loans to deposits and borrowed funds to total assets.
• Bank Run: A situation where many depositors withdraw their funds simultaneously due to concerns about the bank's solvency.
• Deposit Insurance: Protection for depositors up to a certain limit, intended to prevent bank runs by providing confidence in the safety of deposits.
• Liability Structure: The composition of a bank's liabilities, which influences its liquidity risk and funding cost.
• Retail Time Deposits: Deposits with fixed maturities and covered by deposit insurance, offering lower withdrawal risk due to early withdrawal penalties.
• Wholesale Time Deposits: Large fixed-maturity deposits not fully covered by deposit insurance, often negotiable and with competitive rates.
• Chapter 6: Prudential Regulation*
• Prudential Regulation: Focuses on monitoring and supervising financial institutions, emphasizing asset quality and capital adequacy.
• Systemic Regulation: Concerns the safety and soundness of the financial system as a whole.
• Deposit Insurance: Guarantees that depositors will receive their funds up to a certain limit if a bank fails.
• Lender-of-Last-Resort: The role of central banks to provide funds to financially troubled banks that cannot find other sources of capital.
• Conduct of Business Regulation: Governs how financial institutions conduct business, including fair practices and integrity.
• Bank Capital: The primary defense against insolvency, consisting of equity, retained earnings, and other capital instruments.
• Basel Accords: International banking regulations that include capital requirements and risk management standards.
• Risk-Weighted Assets (RWA): Assets categorized according to their risk level to determine capital requirements.
• Market Risk: The risk related to changes in market conditions, such as interest rates and asset prices.
• Operational Risk: The risk of loss resulting from inadequate internal processes or external events.
• Credit Risk Measurement: - Standardized Approach: Uses external credit ratings to assess risk.- Internal Ratings-Based (IRB) Approach: Allows banks to use their own risk assessment models.
• Value-at-Risk (VaR): A statistical technique to quantify risk; measures the maximum expected loss over a specific period under normal market conditions.
• Pillars of Basel II and III: - Pillar 1: Sets minimum capital requirements.- Pillar 2: Focuses on regulatory review and risk management.- Pillar 3: Promotes market discipline through disclosure requirements.
• Common Equity Tier 1 (CET1): The core measure of a bank's financial strength from a regulator's point of view.
• Tier 1 and Tier 2 Capital: Components of bank capital, with Tier 1 being the core capital and Tier 2 being supplementary.
• Capital Conservation Buffer: An additional layer of common equity to absorb losses during periods of financial stress.
• Countercyclical Capital Buffer (CCyB): A buffer of capital that banks must hold during periods of high credit growth.
• Global Systemically Important Banks (G-SIBs): Banks whose distress or failure would cause significant disruption to the global financial system.
• Leverage Ratio: A measure to restrict the level of leverage banks undertake, defined as Tier 1 Capital to Total Exposure.
• Liquidity Ratios: - Liquidity Coverage Ratio (LCR): Ensures banks have enough liquid assets to cover short-term liquidity demands.