BIF 4-6
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Questions and Answers

What is the primary difference between fixed-rate and floating-rate loans?

  • The lender's credit risk assessment
  • The presence of collateral
  • Whether the interest rate adjusts with market rates (correct)
  • The loan repayment schedule

    • Which type of loan is backed by collateral?

  • Syndicated loan
  • Secured loan (correct)
  • Unsecured loan
  • Floating-rate loan

    • What is the role of covenants in loan agreements?

  • Setting the loan interest rate
  • Limiting or prescribing borrower behavior (correct)
  • Deciding the loan duration
  • Determining the loan amount

    • What does Euribor reflect?

    <p>Interest rate at which euro interbank term deposits are offered</p> Signup and view all the answers

    What does credit risk premium compensate lenders for?

    <p>Borrower default risk</p> Signup and view all the answers

    How does asset transformation relate to financial institutions?

    <p>Converting deposits into loans</p> Signup and view all the answers

    What does the term 'Rollover Risk' refer to in liquidity risk management?

    <p>The risk associated with renewing short-term funding under unfavorable conditions</p> Signup and view all the answers

    Which measure quantifies the risk by determining the maximum expected loss under normal market conditions?

    <p>Value-at-Risk (VaR)</p> Signup and view all the answers

    What is the primary focus of Pillar 2 in the Basel II and III Accords?

    <p>Regulatory review and risk management</p> Signup and view all the answers

    What does the Liquidity Coverage Ratio (LCR) ensure for banks?

    <p>Sufficient liquid assets to cover short-term liquidity demands</p> Signup and view all the answers

    Which term describes the process of selling loans or converting them into securities to raise liquidity?

    <p>Securitization</p> Signup and view all the answers

    What is the role of central banks as 'Lender-of-Last-Resort' in the financial system?

    <p>Provide funds to troubled banks when other sources are unavailable</p> Signup and view all the answers

    'Credit Risk Measurement' can be conducted using which approach that allows banks to use their own risk assessment models?

    <p>'Internal Ratings-Based (IRB) Approach'</p> Signup and view all the answers

    'Common Equity Tier 1 (CET1)' is considered as:

    <p>'The core measure of a bank's financial strength from a regulator's point of view'</p> Signup and view all the answers

    'Capital Conservation Buffer' serves as:

    <p>'An additional layer of common equity to absorb losses during financial stress'</p> Signup and view all the answers

    'Systemic Regulation' involves:

    <p>'Concerns safety and soundness of the financial system as a whole'</p> Signup and view all the answers

    What does the Linear Probability Model estimate?

    <p>Probability of default</p> Signup and view all the answers

    Which formula represents the Expected Return on a Loan?

    <p>Expected Return = Interest Rate + Credit Risk Premium - Expected Loss</p> Signup and view all the answers

    What is the purpose of Concentration Limits in credit risk management?

    <p>Set maximum limits on exposure to a single borrower or sector</p> Signup and view all the answers

    What is the primary function of a bank's Minimum Reserve Requirements?

    <p>Mandate cash reserves with the central bank</p> Signup and view all the answers

    Which term refers to the risk of being unable to meet contractual obligations due to insufficient funds?

    <p>Liquidity Risk</p> Signup and view all the answers

    What does the asset-side reason for liquidity risk entail?

    <p>Unforeseen loan commitments requiring immediate funding</p> Signup and view all the answers

    How is the Financing Gap calculated?

    <p>$Financing Gap = Average Loans - Average Deposits$</p> Signup and view all the answers

    What does Migration Analysis help manage?

    <p><strong>Credit Risk Concentration</strong> changes over time</p> Signup and view all the answers

    Which term focuses on reducing risk by holding varied loans with different risk profiles?

    <p><strong>Loan Portfolio Diversification</strong></p> Signup and view all the answers

    What is the primary measure used to assess the return on capital adjusted for risk?

    <p>RAROC (Risk-Adjusted Return On Capital)</p> Signup and view all the answers

    What is the primary purpose of covenants in loan agreements?

    <p>To restrict the borrower's behavior for the lender's protection</p> Signup and view all the answers

    What does Euribor reflect?

    <p>The interest rate on euro interbank term deposits in the eurozone</p> Signup and view all the answers

    What is the key difference between secured and unsecured loans?

    <p>Secured loans rely on the borrower's creditworthiness, while unsecured loans are backed by collateral</p> Signup and view all the answers

    What does the credit risk premium compensate lenders for?

    <p>Potential losses due to borrower default</p> Signup and view all the answers

    How does asset transformation relate to financial institutions?

    <p>It is a process by which institutions convert deposits into loans</p> Signup and view all the answers

    What does loan concentration risk refer to?

    <p>The risk arising from excessive reliance on a single source of funding for loans</p> Signup and view all the answers

    What does the Duration and Capital at Risk model help assess?

    <p>Loan risk with interest rate changes</p> Signup and view all the answers

    What is the primary purpose of Migration Analysis in credit risk management?

    <p>Tracking changes in credit quality over time</p> Signup and view all the answers

    What is the primary function of a bank's Minimum Reserve Requirements?

    <p>Ensuring liquidity through mandatory cash reserves</p> Signup and view all the answers

    What does the term 'Asset-Side Reason' in liquidity risk management refer to?

    <p>Unforeseen loan commitments requiring immediate funding</p> Signup and view all the answers

    How is the Financing Gap calculated for a bank?

    <p>(Average Loans - Average Deposits)</p> Signup and view all the answers

    Which measure helps quantify a bank's reliance on borrowed funds to cover its financing gap?

    <p>Liquidity risk exposure</p> Signup and view all the answers

    What does the term 'Retail Time Deposits' represent in liquidity management?

    <p>Deposits with fixed maturities and covered by deposit insurance</p> Signup and view all the answers

    What is the primary focus of the Liquidity Coverage Ratio (LCR) for banks?

    <p>Ensuring sufficient high-quality liquid assets to cover short-term obligations</p> Signup and view all the answers

    Which term describes the risk of many depositors withdrawing their funds simultaneously due to concerns about a bank's solvency?

    <p>Bank run</p> Signup and view all the answers

    'Stored Liquidity Management' in liquidity risk entails what action by a bank?

    <p>Utilizing cash reserves to meet liquidity needs</p> Signup and view all the answers

    What is the purpose of the Countercyclical Capital Buffer (CCyB)?

    <p>To provide emergency funding during liquidity crises</p> Signup and view all the answers

    What does the Liquidity Coverage Ratio (LCR) ensure for banks?

    <p>Market discipline through disclosure requirements</p> Signup and view all the answers

    How is the Tier 1 Capital defined in banking terms?

    <p>Liquid assets earmarked to cover liquidity demands</p> Signup and view all the answers

    What is the role of the Basel Accords in international banking?

    <p>Providing funds to financially troubled banks</p> Signup and view all the answers

    What does the Risk-Weighted Assets (RWA) measure in banking terms?

    <p>Internal processes and external events</p> Signup and view all the answers

    What does the term 'Securitization' involve in raising liquidity?

    <p>Selling loans at discounted prices during crises</p> Signup and view all the answers

    'Credit Risk Premium' is charged by lenders for what purpose?

    <p>To promote market discipline</p> Signup and view all the answers

    Study Notes

    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.

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    Description

    Test your knowledge on important terms from Chapter 4 on Loans and Credit Risk, including concepts like Credit Risk, Asset Transformation, Loan Concentration Risk, and Interest Rate types. Each term comes with a simplified explanation or formula.

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