bank management

Question 1

Managing credit risk

Answer 1

• Screening and information collection
• Specialisation in lending
• Monitoring and enforcement of restrictive covenants (requires the borrower to either take or abstain from a specific actions)
• Long-term customer relationships
• Loan commitments (Assuranceby banktomake future loans if required)
• Collateral and compensating balances
• Credit rationing

Question 2

Managing market and income risk

Answer 2

Having rate sensitive liabilities of greater value than rate sensitive assets leads to a decline in Net Interest Income if interest rates go up.

Having fixed income liabilities of shorter maturity than fixed-income assets leads to a decline in the mark-to-market value of its equity if interest rates go up and a rise if they go down.

One way to reduce income risk is to match the value of rate-sensitive assets and liabilities as closely as possible.

Likewise, to reduce market risk, a strategy might be to match the maturity structure of fixed income liabilities and assets.

However, in general, a bank’s profitability depends on having rate sensitive liabilities of greater value than rate sensitive assets and fixed income liabilities of shorter maturity than fixed income assets. It therefore has to trade-off profitability against market and income risk.