Bank risk measurment & risk management

Question 1

Sensitivity

Answer 1

Variation of the future outcome for a change in a parameter.

Question 2

Interest Rate Risk

Answer 2

A common example of sensitivity in banking, arising due to fluctuations in interest rates.

Question 3

Impact of Interest Rate Changes on Banks

Answer 3

• Deposits incur interest costs, and loans generate interest revenue.
  
  • Interest rates fluctuate due to economic conditions and monetary policy.
  • Variability in interest rates affects Net Interest Income (NII) and Net Interest Margin (NIM), impacting bank profitability.

Question 4

Sources of Interest Rate Risk

Answer 4

Movements in interest rates can negatively impact NII and NIM.
* Funding gap: Bank assets and liabilities do not reprice simultaneously, leading to potential negative changes in NII.

Question 5

Managing Interest Rate Risk (ALM & ALCO)

Answer 5

Asset and Liability Management (ALM) measures and manages interest rate risk.
* Asset and Liability Management Committee (ALCO) oversees ALM strategies.
* GAP Analysis is used to assess risk by measuring the difference between rate-sensitive assets (RSAs) and rate-sensitive liabilities (RSLs).

Question 6

Steps in GAP Analysis

Answer 6

1. Develop an interest rate forecast.
   
   2. Determine time intervals for asset/liability repricing.
   3. Group assets and liabilities accordingly.
   4. Forecast NII changes based on interest rate changes.
   5. Calculate GAP:

GAP_t = RSA_t - RSL_t

Question 7

GAP Interpretation

Answer 7

Negative GAP: More RSLs than RSAs → Rising interest rates decrease NII.
* Positive GAP: More RSAs than RSLs → Rising interest rates increase NII.
* Zero GAP: Interest rate changes do not impact NII (rare in practice).

Question 8

Volatility

Answer 8

Measures variations around the mean of a random variable.

Question 9

Credit Risk

Answer 9

= loan charge offs / total loans

or

= loan losses/ total loans

Question 10

Variance

Answer 10

: Sum of squared deviations from the mean, weighted by probabilities.

Question 11

Volatility:

Answer 11

Square root of variance

Question 12

Implied volatility:

Answer 12

Market expectations of price movements

Question 13

Realized volatility:

Answer 13

Actual past price movements.

Question 14

banking portfolio risk

Answer 14

risk of loan defaults

Question 15

trading portfolio risk

Answer 15

risk of declining credit standing of security issuers

Question 16

type 1 error

Answer 16

lending to a customer who defaults

Question 17

type 2 error

Answer 17

denying a loan to a creditworthy customer

Question 18

loan charge offs

Answer 18

amount written off as uncollectible

Question 19

loan losses

Answer 19

non current + doubtful loans

Question 20

credit risk measurement

Answer 20

• Credit ratings assess creditworthiness of securities.
  
  • Agencies rate through business cycles, avoiding frequent changes.
  • Many businesses lack ratings → banks conduct internal credit assessments.

Question 21

liquidity risk

Answer 21

inability to meet obligations timely/cost effectivley

Question 22

solution to liquidity risk

Answer 22

holding liquid assets (cash, reserves)

Question 23

liquidity ratio

Answer 23

(cash + gov securities + other liquid assets)/ total assets

Question 24

liquidity risk from trading perspective

Answer 24

liquid assets can be quickly sold and illiquid assets face a wider bid-ask spread so higher trading losses

Question 25

absolute spread

Answer 25

offer price - bid price

Question 26

proportional spread

Answer 26

= (offer price - bid price) / mid-marketprice

Question 27

mid - market price

Answer 27

(offer price + bid price) /2