06.1 Bank Risks and Risk Management

Question 1

Give examples of some bank activities.

• Intermediate between …
• Provide loans
• Provide … and return (interest) for savers
• Finance themselves with …
• … compared to other corporations
• Debt can be short term (demandable)

Answer 1

savers and users of funds
payment services
debt and equity
Much more levered

Question 2

Explain how bank assets are sub-divided/grouped.

Answer 2

ASSETS: Cash/Reserves, Securities, Loans
LOANS can be commercial or consumer loans

Question 3

Bank assets
* Commercial and Industrial loans (C&I) – …
* Consumer loans
– …
* Securities
– …
* Cash and reserves

Answer 3

Transaction, working capital, term loans…

Direct loans, credit cards, mortgages

Commercial paper, government securities…

Question 4

Lending

Answer 4

• Spot market: Originate and keep them on their own books
• Forward market: Loan commitment: Promise to lend in the future

Question 5

Banks and risks
* Credit risk
* …
* Interest rate risk
* …
* Operational risk
* …
* Climate risk
* …
* Political risk

Answer 5

Liquidity risk

Currency risk

Business risk

Country risk

Question 6

Explain credit risk.

• Banks hold …
• Credit risk: Banks can experience…
• Capital acts as a buffer and …

What elements of the balance sheet does it affect?

Answer 6

risky/illiquid (loans) assets.
losses from the risky assets.
can help prevent costly failures.

Assets: Loans
Liabilities: Equity

Question 7

Explain Liquidity Risk.

• Banks hold …
• Liabilities (short-term debt or deposits) usually have …
• Liquidity risk: …
• Can lead to the failure of the bank.

Answer 7

risky/illiquid assets (loans) typically with long maturities.

short maturity (maturity/liquidity mismatch).

When debt holders want to withdraw (or not rollover) bank needs to come up with cash. Costly liquidation.

ASSETS> Cash; Loans
LIABILITIES> Short-term debt

Question 8

Interest Rate risk

• Banks hold …
• Liabilities (short-term debt or deposits) usually have …
• Interest rate risk: …

Answer 8

assets/loans typically with long maturities.

short maturity (maturity mismatch).

When interest rates change, it can expose the bank to interest rate risk.

ASSETS> Securities/Loans
LIABILITIES> Short-term debt

Question 9

Currency risk

• … can be in foreign currency.
• … can expose the bank to currency risk.
• Currency mismatch between …

Answer 9

Part of assets and liabilities
Changes in the exchange rate
assets and liabilities.

(how does that impact the balance sheet??-> to answer irl)

Question 10

Risks
* Credit risk: …
* Liquidity risk: Basel III, LCR, NSFR
* Interest rate risk: …
* Currency risk
* Operational risk: … (LIBOR and foreign exchange scandals), sanctions, money laundering
* Business risk: …
* Climate risk: Drought, floods, climate change

Answer 10

Basel Capital Requirements
Duration analysis

Compliance with rules and regulation

Competition from bank-like entities (FINTECH)