Chapter 8 - Strategy Flashcards
What is the main focus of the strategy setting and implementation process in a banking operation?
The development of an effective strategy and identification of key elements of the strategic plan.
What two aspects are fundamental to the crafting of an effective strategy?
- Fundamental analytic work
- Deep understanding of the organization
What is the essence of strategy?
Integration of information and distillation of relevant actions to improve competitive positioning.
What can a lack of effective strategy lead to for most organizations?
A ‘slow death’ due to gradual loss of commercial franchise.
What key aspect hastens the decline of banks compared to other organizations?
Banking is built on trust and confidence.
What are the consequences of a bank losing the trust of its clients?
- Deposits are withdrawn
- New funding dries up
What should a strategic plan for a bank include to be effective?
Robust capital and liquidity management plans.
How does a strategic plan differ from an annual business plan or budget?
A strategic plan describes development over 3 to 5 years, while a business plan captures activities and outcomes for the next year.
What is the first step in the strategic planning process?
An honest and open interrogation of the ‘current reality’ of the enterprise.
What are the three key outputs from the ‘current reality’ stage?
- Understanding of the imperative for change
- Clear view of business aspects for future development
- Clarity on market positioning and strategic objectives
What is a vision statement?
A description of what the organization should become over the following 5 years.
What should a vision statement capture?
The imagination of both internal and external stakeholders.
What is the third stage of the strategic planning process?
Identifying high-level strategic initiatives to move towards the preferred future.
What is necessary for the successful execution of strategic initiatives?
Careful consideration of support and resources.
What can ‘management stretch’ lead to?
Problems, including insufficient attention to emerging risks.
What influences the development of a strategic plan?
- Stakeholders expectations
- Macro and micro environment
- Competitive landscape
- Internal core competencies
What role do stakeholder expectations play in strategic planning?
They assist in defining financial targets and product/service delivery expectations.
What must be understood regarding the macro-economic environment?
Predictions can be dangerous, and the strategy should be robust under various scenarios.
What is critical for a bank’s strategic plan concerning capital and liquidity?
The ability to withstand macro-economic and stress scenarios.
What does the competitive landscape require from a bank’s strategic plan?
A deep understanding of customer franchise and competitor actions.
What is the definition of ‘core competencies’?
Areas where an entity excels and can leverage for new developments.
What should a bank do if it lacks certain competencies?
Buy in or develop them internally.
What is a practical limitation of a vision statement?
It is based on a view of the future, which may not be correct.
True or False: The board of the enterprise must agree on the strategic plan.
True.
What is the primary concern when a bank ventures into areas where it lacks expertise?
Inadequate expertise may lead to poor strategic decisions and implementation failures
This involves understanding the importance of cultural fit when acquiring new competencies.
What should a bank be aware of when implementing a coherent strategy?
The bank needs to be aware of its lack or possession of expertise in products or markets
This ensures informed decisions are made in unfamiliar areas.
What does the adequacy of internal resources refer to?
It questions whether the entity has the necessary resources to undertake its strategic plan
This includes people, skills, processes, and financial resources.
What is the significance of organisational structure in relation to strategy?
Structure should be shaped by factors emerging from the strategic plan to support the plan effectively
This ensures accountability and effective execution.
Why is the future of business units that do not fit the defined strategy important?
Such units can be management diversions and sources of problems, potentially needing to be sold
This highlights the need for alignment between strategy and operations.
What central role do capital and funding play for banks?
They are crucial to any strategic plan, ensuring robustness across business cycles and stress scenarios
Regulatory requirements often mandate this consideration.
How must a strategic plan align with a bank’s risk appetite?
It must be supported by a measurable risk appetite statement approved by the board
This integration helps monitor and control risks effectively.
What is typically included in an outline financial plan for a bank?
Forecasts, income statements, balance sheets, and key financial ratios
Plans should cover both base case scenarios and adverse scenarios.
What is the purpose of the annual strategy event for a bank?
To review strategy, assess progress, and plan for the future
It allows the board to consider all parts of the bank’s strategy simultaneously.
What types of issues are reviewed during the annual strategy event?
Progress versus plan, market outlook, core competencies, division strategies, and financial forecasts
This comprehensive review supports strategic alignment.
What competencies are essential for a bank’s strategy team?
Technical knowledge of banking, analytical skills, communication skills, and cultural qualities
Diversity in backgrounds enhances problem-solving capabilities.
True or False: A bank’s strategy should remain unchanged over time.
False
Strategies should adapt to respond to market changes and competitive pressures.
What are the four steps in dealing with strategic opportunities and threats?
- Initial appraisal
- Prioritisation
- Strategic solution and plan
- Formal approval
These steps guide the strategic decision-making process.
What was RBS’s initial strategic approach in the supermarket banking initiative?
To establish a banking business with a UK supermarket group, using a phone and internet model
This alternative aimed to reduce costs and leverage supermarket customer loyalty.
What advantage did RBS find in its limited branch network?
It reduced concerns about internal competition in supermarket banking
This turned a weakness into a strategic advantage.
What is the basic business model of a bank?
Intermediation between depositors and borrowers while managing various risks
This model has remained essentially unchanged for centuries.
What is the basic business model of a bank?
Intermediation between depositors and borrowers, managing various risks for viability and sustainability.
What are the main risks for traditional banks?
- Credit risk
- Market risk
- Operational risk
Why do banks hold capital?
To cover losses arising from risks and ensure stability during adverse stress scenarios.
What assets do banks hold to finance expected withdrawals?
High-quality liquid assets.
What are the universal strategic and financial objectives of a bank?
Focus on customers, products, strategic initiatives, and necessary resources.
What metrics are included in a bank’s financial plan?
- Return on equity
- Cost-to-income ratio
- Growth in earnings per share
What is a risk appetite statement?
A statement that outlines controls on capital and liquidity adequacy.
What key strategic questions might a bank consider?
- What returns do investors require?
- Which markets with which products?
- What resources are needed?
- What should the financial structure be?
What was a significant outcome of the banking crisis of 2007-2008?
Recognition of the need to consider macro-prudential as well as micro-prudential risks.
What regulatory changes were introduced by Basel III?
- Increased minimum equity capital to 4.5%
- Introduction of Liquidity Coverage Ratio
- Introduction of Net Stable Funding Ratio
What is the ‘herd mentality’ in banking?
A phenomenon where investors follow trends, leading to asset bubbles.
What is the significance of countercyclical capital buffers?
They can be released during periods of economic stress to support banks.
How did Basel III regulations help banks during the Covid-19 pandemic?
Banks had higher capital levels and capital buffers to absorb economic shocks.
What is the importance of capital management in a bank’s strategic plan?
It ensures sustainable banking and capital adequacy.
What are some typical objectives of a bank’s strategic plan?
- Financial objectives
- Customer and competitive environment
- Business capacity and capabilities
- Skills and people
What are key financial ratios monitored by a bank’s board?
- CET1 capital ratio
- Total capital ratio
- Leverage ratio
- Liquidity Coverage Ratio
- Cost to income ratio
What is the focus of the balanced scorecard approach in banking?
To assess various aspects of a bank’s performance and strategy.
Fill in the blank: The banking crisis highlighted the limitations of focusing on _______ without adjusting for risk.
return on equity
True or False: The Basel II regulations specified requirements for liquidity.
False
What is the relationship between capital and return on equity (ROE) as observed post-crisis?
Higher capital levels have led to lower ROEs than before the crisis.
What type of income do banks aim to improve in their financial plans?
The quality of income, focusing on annuity versus one-off income.
What challenges do banks face regarding unexpected risks?
Events like cyberattacks or climate change may arise unexpectedly.
What are key financial ratios typically monitored by banks?
- CET1 capital ratio
- Total capital ratio
- Leverage ratio
- Liquidity Coverage Ratio (LCR)
- Ratio of customer loans to customer deposits
- Ratio of net interest income to total income
- Cost to income ratio
- Ratio of IFRS 9 provisions to loans
- Return on equity (ROE)
These ratios help assess a bank’s financial health and operational efficiency.
What growth metrics are likely monitored by the board of a bank?
- Customer loans
- Risk-weighted assets
- Customer deposits
- Total income
- Total expenses
- Provisions for expected credit losses
- Earnings per share
Monitoring these metrics helps ensure sustainable growth without excessive risk.
True or False: Investors prefer growth with excessive volatility.
False
Investors typically seek growth without excessive volatility to mitigate risks.
What questions should be considered when evaluating a proposed strategic plan?
- How helpful is the vision statement?
- Is the strategy aligned with the vision?
- How realistic is the evaluation of the current reality?
- Are the proposed initiatives grounded in reality?
- Are strategic targets and objectives clear?
- Is there accountability for delivery?
- Can progress be effectively monitored?
- Is leadership committed to the plan?
- Will there be sufficient capital for initiatives?
- What is the risk profile of the planned new balance sheet?
These questions help assess the feasibility and alignment of the strategic plan.
Fill in the blank: A bank may achieve economies of scale by buying another bank in the same country, known as an __________ acquisition.
[in-market]
In-market acquisitions allow banks to increase scale in their chosen products.
What is a market extension acquisition?
Buying another bank in a different country to achieve limited economies of scale
Unlike in-market acquisitions, these often require adaptation to different banking regulations.
What is a potential strategic concern when acquiring another business?
Culture clash
This can arise between the acquiring bank and the acquired business, affecting integration.
True or False: A bank might sell a subsidiary business if it is not core to its strategy.
True
Selling non-core businesses allows banks to focus on their primary operations.
What are some advantages of joint ventures over partnerships?
- A joint venture board drives the business forward
- In event of termination, the seller gets value from the joint venture
- Customers remain with the ongoing joint venture business
Joint ventures allow for shared risks and rewards, making them a strategic option.
What factors contribute to estimating potential transaction benefits in acquisitions?
- Cost savings (25%-40% for in-market transactions)
- Income benefits from a larger customer base
Investors generally have more confidence in cost savings than in income benefits.
What social issues might be considered in an acquisition?
- Name of the ongoing entity
- Location of the head office
- Senior management positions
These factors can influence negotiations and the acceptance of the acquisition.
What financial ratios might be used to assess the acquisition price?
- Price to earnings
- Price to assets
- Price to net asset value
These ratios help place a value on the target based on financial performance.
Fill in the blank: A bank uses a __________ model to ensure an acquisition creates value for its shareholders.
[discounted cashflow (DCF)]
The DCF model assesses the return on equity against the cost of equity capital.
What should a bank demonstrate regarding capital and liquidity when presenting an acquisition?
A prudent approach to capital and liquidity
This includes ensuring capital ratios remain adequate post-acquisition.
What is the term introduced in the 1990s by Clayton Christensen that describes the potential for new entrants to disrupt established firms?
Disruptive innovation
Introduced in an article titled ‘Disruptive Technologies: Catching the Wave’ by Bower and Christensen.
What behavior do established firms exhibit that allows new entrants to gain significant market shares under disruptive innovation?
Fail to recognize the importance of innovative products
This can be due to lack of demand or reluctance to invest in new products.
What is a key example of disruptive innovation in the insurance sector?
Direct Line
Direct Line offered motor insurance directly to customers, bypassing intermediaries.
How has online banking changed the competitive landscape for new banks?
Eliminated the need for branch networks
This shift was accelerated by Covid-19 lockdowns, facilitating entry for new banks.
What legislation in the EU and UK allows customers to authorize the transfer of their current banking data to third parties?
Payment Services Directive 2 (PSD2) and Open Banking
Open Banking was launched in the UK in January 2018.
What was the growth in the number of Open Banking payments from 2018 to 2020?
From 320,000 to over 4 million
This growth illustrates the rapid adoption of Open Banking services.
What are the two main advantages of large established banks in response to potential disruptive innovation?
- Economies of scale
- Ability to make large investments in IT capabilities
What consequence does high take-up of new digital services have for banks?
Loss of direct relationships with customers
Other firms like aggregators may take over customer-facing distribution activities.
What are the four potential future scenarios of retail banking identified by the Financial Conduct Authority in 2018?
- Bank as a Utility
- Big Switch
- Gradual Evolution
- Waterbed
What is the primary risk associated with ESG from a banking perspective?
Financial or reputational harm from environmental, social, and governance factors
This can stem from counterparties and the bank’s own operations.
What does environmental risk encompass?
Risk relating to the physical environment, including climate change risk
This type of risk has gained significant focus in recent years.
What are the 17 social development goals (SDGs) published by the UN intended for?
Tracking progress towards globally accepted social development targets
These goals include areas like poverty, hunger, health, and education.
What does governance risk stem from?
Poor governance structures
Good corporate governance is a predictor of financial stability.
How can an ESG score be interpreted?
Similar to a credit score, reflecting ESG risk
Most banks currently rely on external providers for ESG scores.
What is a critical consideration when assessing the investment in new technologies for banks?
Alignment to business strategy
This includes alignment to IT strategy and the needs of immediate users.
What financial aspects must be established for new technology projects in banks?
- Solid business case
- Adequate return on investment
- Cost-benefit analysis
What is a key requirement for the implementation of new systems and technology in banks?
Involvement of skilled resources
This includes developers, project managers, and business analysts.
What is the purpose of defining key performance indicators during system implementation in banks?
To monitor how the system is working
Indicators may include control failures and access control issues.
What internal frameworks must be adhered to during technology implementation in banks?
- Data management policies
- IT risk management policies
- BCBS 239 principles
What is the major risk associated with the adoption of machine learning algorithms in banking?
Potential bias leading to mis-selling
Regulators may be cautious about the use of such algorithms.
What might a bank need to do if a system is managed centrally but used in a different location?
Obtain regulatory approval
This is particularly relevant for cloud-based systems.
What do ESG scores indicate for banks?
ESG scores indicate the ESG risk presented by counterparties and allow banks to assess this risk while building internal risk management structures.
What are the main categories evaluated in a general ESG scorecard?
- Environmental
- Social
- Governance
List some factors under the Environmental category of an ESG scorecard.
- Waste reduction and recycling
- Emissions intensity and renewable energy use
- Water use efficiency and risk management
- Sustainable sourcing and biodiversity protection
Name key factors assessed under the Social category of an ESG scorecard.
- Employee health and safety
- Fair wages
- Diversity and inclusion
- Supply chain due diligence
- Human rights impact assessment
- Community engagement
What does the Governance category of an ESG scorecard focus on?
- Internal controls
- Whistleblowing policy
- Regulatory fines
- Board composition and diversity
- Executive compensation
True or False: The weighting of each ESG category and metric is the same across all organizations.
False
How can an ESG scorecard be utilized by organizations?
- Assess ESG performance over time
- Identify areas for improvement
- Track progress towards ESG goals
- Compare ESG performance of different companies
What is a significant risk associated with the use of ESG scores?
Model risk due to unvalidated assumptions and data underlying the scores.
What general issue complicates the selection of ESG score providers?
There are over 100 ESG score providers with varying methodologies, inputs, and subjective information.
What does the term ‘black box issue’ refer to in the context of ESG scores?
It refers to the proprietary nature of some ESG score providers, limiting validation of scores and understanding of the methodologies used.
Fill in the blank: ESG scores may ______ some of the risk with a counterparty due to overlap in assessed factors.
double count
What challenges do banks face in integrating ESG scores into credit risk management?
- Deciding on the use of ESG scores for reporting, risk appetite, capital calculations, etc.
- Incorporating ESG scores into risk management processes
- Difficulty in establishing a clear relationship between ESG and credit risk
What are the two key terms related to climate change?
- Adaptation
- Mitigation
True or False: Adaptation refers to actions taken to reduce the impact of climate change.
True
What is the goal of The Paris Agreement?
To limit global warming to below 2°C relative to pre-industrial levels by the middle of this century.
What significant change has occurred in global average temperatures since the pre-industrial revolution?
Global average temperatures have increased by approximately 1.5°C.
What are the two sub-risk types of climate risk identified by the TCFD?
- Physical risk
- Transition risk
Fill in the blank: The major contribution to greenhouse gases and global warming is ______ from burning fossil fuels.
carbon dioxide (CO2)
What does climate risk represent for financial institutions?
The risk to an institution of the changing climate.
What is the expected impact of climate change on rainfall patterns in South Africa?
- Areas with high rainfall will likely receive more rainfall
- Areas with low rainfall will likely receive less rainfall
What is a challenge faced by unlisted firms regarding ESG scores?
Limited data availability and reporting requirements compared to listed firms.
What is one potential consequence of using subjective analysis in ESG score assessments?
Difficulty in comparing scores at different points in time.
What is the expected rainfall trend in Eastern parts of South Africa?
Increase in rainfall
This contrasts with the Western region, which is expected to see a decrease.
What is the anticipated decline in average rainfall for some parts of the Western Cape?
Up to 15% decline
Understanding climate trends is crucial for measuring climate risk.
What are the two main types of climate risk defined by the TCFD?
Physical risk and transition risk
Physical risk is further divided into chronic and acute physical risk.
What is acute physical risk?
Risk arising from event-driven risks, such as extreme weather events
Examples include floods and fires.
What is chronic physical risk?
Risk arising from long-term weather pattern changes
Examples include chronic heatwaves and rising sea levels.
What are the components of transition risk?
- Market risk
- Technology risk
- Policy and legal risk
- Reputational risk
What does funded emissions refer to?
Emissions arising from activities made possible by bank funding
Banks must understand their indirect impact on emissions.
What is a stranded asset?
An asset that has suffered an unanticipated or premature write-down
Stranded assets represent a key risk in the climate risk space.
What factors can cause an asset to become stranded?
- Technological change
- Changing climate patterns
How does climate risk enhance other risk types?
It can cause defaults, increase operational risk, and impact credit risk
For example, a climate hazard may lead to increased credit risk.
What is the expected impact of climate risk on credit risk?
Increased probability of default (PD) and loss given default (LGD)
This is due to physical and transition risks affecting firms’ financial positions.
What role does insurance play in mitigating climate risk?
Insurance protects a counterparty’s financial position and the value of the underlying security
For example, repaired homes after floods can prevent mortgage defaults.
What is the potential impact of climate change on liquidity risk?
Increased costs may reduce individuals’ savings and affect credit product utilization
This impacts both retail and wholesale funding.
What is underwriting risk in the context of climate change?
The risk insurers face due to climate change-related losses
This affects banks through the availability and pricing of insurance.
What are the key components of a general-purpose Climate Risk model?
- Hazard/driver
- Exposure
- Vulnerability
What are some examples of climate hazards noted by the IPCC?
- Flood
- Fire
- Drought
- Heat waves
- Sea level rise
True or False: Climate risk only affects financial markets in a direct manner.
False
Climate risk can have indirect effects through supply chains and market sentiment.
What is market risk in the context of climate change?
Risk arising from asset price adjustments due to climate risk
This can lead to abrupt swings in asset prices.
What is a common method for incorporating climate risk into market risk measurement?
Value at Risk (VaR) approach
This accounts for climate risk factors.
What is the anticipated effect of climate change on operational risk for banks?
Banks’ operations may be impacted by climate hazards affecting their facilities
Business interruption can also occur due to employee impacts.
How might climate change affect the underwriting process for banks?
Insurers may exclude high-risk areas, increasing costs and impacting loan writing
This is particularly relevant for mortgage products.
What could lead to stranded assets on a macroeconomic level?
Reliance on a single industry, such as fossil fuels
Countries heavily dependent on fossil fuel generation face significant transition risk.
What are some climate hazards of concern noted by the IPCC?
- Flood
- Fire
- Drought
- Heat waves
- Sea level rise
The list is not exhaustive and varies by location.
What must one assess when performing a physical risk assessment?
Whether a counterparty is exposed to any climate hazards
This includes considering the location of the counterparty and the specific impacts on their portfolio.
What is meant by ‘vulnerability’ in the context of climate risk?
The extent to which a counterparty mitigates losses due to climate change
For example, having insurance can reduce vulnerability.
True or False: Transition risk has existed for a long time.
False
Transition risk is a relatively new concept, making data limited.
What are the four data types relevant for climate risk modeling?
- Climate data
- Climate hazard data
- Climate-related data
- Exposure data
These categories can overlap.
What are the three main sources of climate data for physical risk?
- Weather station data
- Satellite data
- Interpolated data
Each source has its own strengths and weaknesses.
What is a major issue with weather station data?
Data completeness and limited number of weather stations
Gaps in data can occur due to equipment failure or insufficient coverage.
What is a limitation of satellite data in climate risk modeling?
Limited time granularity and potential inaccuracies due to cloud cover
Satellites can only capture specific regions at specific times.
What is the purpose of geocoding exposure data?
To ensure accurate modeling of climate risk by location
It helps avoid summarizing climate data across multiple regions.
Fill in the blank: Climate variables include _______.
- Rainfall
- Average temperature
- Maximum temperature
- Minimum temperature
- Humidity
- Wind speed
- Snowfall
- Air pressure
Each variable may have trends reflecting climate change.
What is the focus of transition risk data?
Sectoral granularity rather than geographic granularity
Different sectors have varying levels of carbon intensity.
What complicates the sourcing of firm emissions data?
Many firms do not publicly report their emissions
This leads to reliance on estimates or proxies which can introduce noise.
What is necessary for assessing stranded assets?
A granular view of the firm’s balance sheet and expert judgement
This helps identify which assets may become stranded due to climate risks.
What should climate risk measurement align with?
Internal models for other risk types
This ensures consistency and reduces model risk.
What is the role of vulnerability in climate risk modeling?
It includes assessing insurance coverage and historical exposure
Understanding vulnerability helps in calibrating risk assessments.
What does a firm’s transition plan indicate?
How the firm plans to manage its transition risk and reduce emissions
Feasibility of achieving the plan is an important consideration.
What is the Task Force for Climate Disclosures (TCFD) known for?
Producing reports and frameworks for climate risk disclosure
Their work includes a comprehensive framework published in 2017.
What is required for effective transition plans?
Significant effort and buy-in from senior management
The quality of publications often reflects this buy-in.
What should be assessed first when considering the transition risk of a counterparty?
Their risk without a transition plan
What is the purpose of additional climate-related reporting?
To ensure that shareholders and stakeholders are aware of the firm’s impact on climate and the steps to reduce it
What does TCFD stand for?
Task Force for Climate Disclosures
What are the four key areas the TCFD recommends firms to disclose information on?
- Governance
- Strategy
- Risk management
- Metrics and targets
What are Scope 1 emissions?
Emissions generated directly by processes and assets owned or controlled by a firm
What are Scope 2 emissions?
Emissions stemming from the generation of purchased electricity
What are Scope 3 emissions?
Emissions arising from indirect activities of a firm, including upstream and downstream activities
Which scope of emissions do banks primarily report?
Scope 3 downstream emissions, referred to as financed emissions
What are the two IFRS Sustainability Standards released in 2023?
- IFRS S1 (General Requirements for Disclosure of Sustainability-related Financial Information)
- IFRS S2 (Climate Related Disclosures)
What does WBCSD stand for?
World Business Council for Sustainable Development
How are emissions classified by WBCSD?
- Scope 1: Direct emissions
- Scope 2: Indirect emissions from purchased electricity
- Scope 3: All other indirect emissions
What is a key consideration for climate risk stress testing compared to normal stress testing?
Climate scenarios are used instead of macroeconomic scenarios
What key factors differentiate macroeconomic stress tests from climate risk stress tests?
- Term: 3-5 years for macroeconomic vs. 30+ years for climate risk
- Number of scenarios: Up to 3 for macroeconomic vs. 3 or more for climate risk
- Scenarios: Historical for macroeconomic vs. generated from climate research for climate risk
What does IAM stand for in climate risk modelling?
Integrated Assessment Models
What are the four categories of climate scenarios offered by NGFS?
- Orderly
- Disorderly
- Hothouse World
- Too Little Too Late
In the context of climate risk scenarios, what does the term ‘Orderly’ mean?
Climate policies are introduced in an orderly fashion over time
What is a fundamental requirement for stress testing in climate risk?
Granularity to capture nuances in climate variables
What is the starting point for any climate risk stress test?
Determining the amount of GHG emissions required for a certain level of global warming
What is the significance of the ‘Delayed Transition’ scenario?
Represents high transition risk but relatively low physical risk
What does the ‘Current Policies’ scenario represent?
Very high physical risk, but little to no transition risk
What is the main purpose of climate risk stress testing?
To evaluate the impact of climate scenarios on financial stability
What is a materiality assessment in the context of portfolio analysis?
An evaluation to identify which portfolios are most sensitive to climate risk
What data is essential for the climate risk modelling exercise?
Exposure data for portfolios, climate hazard, and transition risk driver data
What is the first step in the modelling exercise for climate risk?
Source exposure data for chosen portfolios and relevant climate hazard and transition risk driver data
This includes identifying relevant hazards like fire risk for credit risk assessment.
How does diversification apply to climate risk?
Diversification applies by geography and industry
Even within industries, firms may be impacted differently based on their activities.
What is necessary for a physical risk assessment in climate risk modelling?
Geolocation of exposures
This is critical for accurately assessing physical risks.
What happens if exposure data is not sufficiently geolocated?
The model must be built at a less granular level
This could lead to understated model results.
What is the importance of sourcing climate-related data?
It depends on the chosen hazards and drivers, as not all climate variables are relevant to all hazards
This simplifies the data sourcing exercise.
What is a key consideration when sourcing forecasts under different climate scenarios?
The format of the forecasts, particularly if annual forecasts are needed from five-year increments
Interpolation may be required for annual forecasts.
How is the impact of climate scenarios on a bank determined?
By measuring the impact on balance sheet and income statement items
This is often complex due to the interactions involved.
Which metrics are commonly used to assess credit risk impact?
Key credit risk metrics such as RWAs or impairments
Common metrics help in breaking down the problem by risk type.
What is a significant part of analyzing climate risk stress test results?
Filtering information to make it actionable
The goal is to assess if a bank can survive stressful scenarios.
What does ‘double materiality’ refer to?
The impact of climate change on an institution and the institution’s impact on climate change
It highlights the interrelatedness of emissions and financial institutions.
What is the purpose of a Just Energy Transition (JET) Investment Plan?
To propose an emissions reduction pathway while creating jobs, increasing energy security, and supporting economic growth
JET reflects international focus on vulnerable communities during transitions.
What are the two main ways to set a carbon price?
Through a carbon tax or a market-determined rate
Carbon taxes provide clarity, while market rates offer efficiency but can be variable.
What is a carbon credit?
A certified pledge that one ton of CO2 equivalent has been removed from the atmosphere
Verification is crucial, as inadequate verification can lead to inflated claims.
What are the potential risks associated with using carbon credits?
Reputational risk and the risk of increasing net emissions due to poorly verified credits
Firms may face backlash for perceived inaction on emissions reduction.
What is the role of carbon credits in emissions management?
They can be traded and used to offset emissions from a firm’s operations
This can be a strategy for firms unable to reduce their own emissions directly.
What is the significance of the European Union Emissions Trading System?
It is a market where carbon credits are traded
This market dynamics set the price for carbon credits based on supply and demand.
What does the term ‘Just Transition’ emphasize?
Ethical considerations in transitioning to a lower-emission economy
It aims to ensure vulnerable communities are not adversely affected.
What is social risk?
An area receiving additional focus with a long way to go before a well-defined risk management and measurement framework is available.
What is double-materiality in the context of social risk?
The potential for financial institutions to influence social issues while being affected by them.
What is a sustainable-linked loan?
Loans whose interest rate is influenced by the debtor achieving set environmental or social goals.
What is market-based risk?
Risk associated with shifts in supply and demand in financial markets due to social issues.
What can prolonged income inequality lead to?
Shrinkage of key markets and reduced performance of firms in the sector.
What is policy and legal risk?
Risk associated with changing policy or legal action due to social issues.
What is reputational risk?
Risk of reputational damage due to a bank’s association with social issues.
What is productivity risk?
Risk of reduced employee productivity due to poor employment practices.
What is brain drain?
The movement of skilled individuals out of vulnerable communities and countries.
How does climate risk relate to social risk?
Reputational damages due to climate change can be linked to social risk reputational damage.
What is the purpose of scenario analysis in social risk?
To understand how social risks are likely to evolve into the future.
What does SSP stand for in social risk analysis?
Shared Socioeconomic Pathways.
What is SSP1 known as?
Sustainability, or ‘Taking the Green Road’.
What characterizes SSP3?
Regional Rivalry, or ‘A Rocky Road’, with increased focus on domestic issues and potential environmental degradation.
What does SSP5 emphasize?
Fossil-fuelled development, or ‘Taking the Highway’, with rapid growth driven by fossil fuel exploitation.
What is fair pricing in retail financial products?
Encouraging transparent and simple pricing that allows providers to make reasonable profits.
What is risk-based pricing?
Pricing that reflects the risk level of customers, ensuring fairness in financial services.
What is price discrimination?
Charging different prices to customers for the same product based on their sensitivity to prices.
What is inertia pricing?
A form of price discrimination where loyal customers pay higher prices than new customers.
What are ancillary products in financial services?
Products sold together, often leading to cross-subsidies.
What is the significance of the FCA’s involvement in pricing?
The FCA aims to protect consumers and ensure fair pricing practices in financial services.
What can significant cross-subsidies indicate?
Weak competition in the market.
What are the potential consequences of regulatory intervention in pricing?
Unintended consequences that may arise from regulatory actions.
What was the impact of the banking crisis of 2007 on interest rates?
Policy interest rates were reduced to historically low levels.
What are negative interest rates?
Policy rates set below zero to stimulate economic growth.
Which central banks set policy rates below zero between 2014 and 2016?
European Central Bank, Denmark, Sweden, Switzerland, and Japan.
What is the purpose of negative interest rates?
To stimulate economic growth.
Which central banks set their policy rates at negative levels between 2014 and 2016?
- European Central Bank (ECB)
- Denmark
- Sweden
- Switzerland
- Japan
What happened to yields on 10-year government bonds in certain countries during the same period?
They fell below zero.
How do interest rates on bank loans generally compare to policy rates?
They are generally higher than policy rates but follow their direction.
What might happen if policy rates were reduced to negative levels in countries like the US and UK?
Lower lending rates, stimulating demand for lending and supporting economic growth.
What is largely untested regarding negative interest rates?
The ability of banks to impose negative interest rates on retail deposits.
What behavior might negative interest rates encourage among customers with large deposits?
Investing in property or other assets.
What is net interest margin?
The difference between interest income generated and interest paid out.
What effect would a negative policy rate have on a traditional bank’s net interest income?
It would lead to a reduction in net interest income.
What did the ECB Occasional Paper published in August 2017 find regarding banks in Sweden and Denmark?
Their profitability continued to improve during negative policy rates.
According to the Federal Reserve Bank of San Francisco, how does overall bank profitability change over time under negative interest rates?
It falls below zero after five years.
True or False: The positive effects of the ECB’s negative interest rate policy have exceeded their side effects.
True.
What was a significant difference in bank capital positions before the Covid-19 pandemic compared to the 2007-2008 banking crisis?
Banks had a much stronger capital position.
What is the minimum CET1 capital requirement under Basel III?
4.5% of total risk-weighted assets.
What action did authorities take quickly in response to the Covid-19 pandemic?
Introduced schemes to support individuals and businesses.
What approach did banks take to expected credit losses during the Covid-19 pandemic?
A moderate approach rather than an overly prudent one.
What accounting standard replaced IAS 39 for expected credit losses?
IFRS 9.
What does blockchain technology represent in the context of banking?
A new form of secure, distributed ledger database.
What is required to record new transactions in a blockchain?
Solving a ‘proof of work’ problem.
What is the significance of the longest string of blocks in a blockchain?
It is recognized as the valid blockchain.
Fill in the blank: A bank’s database is a set of _______ that state who owes what and who is owed how much.
1s and 0s.
What happens if someone tries to tamper with data in a closed block of a blockchain?
It would invalidate the proof of work solution.
What do users of the blockchain network need to do to understand ownership and transactions?
Work through all past transactions.
What is the blockchain data base?
The blockchain data base is the collection of ALL transaction records.
What is the primary function of a blockchain?
To create a secure record keeping independent of any single counterparty.
True or False: The blockchain gives a snapshot view of who owns what.
False
What do users of the blockchain network need to do to understand ownership?
Work through all transactions to build a complete picture of ownership.
Fill in the blank: Blockchain can replicate any existing _______.
[database]
What is an example of a use case for blockchain in property rights?
Land or property rights in countries with unreliable registration processes.
What is a non-fungible token?
A token linked to an artwork that cannot be copied and whose ownership can be traced.
Who sold the artwork ‘Everydays: The First 5,000 days’ for $69.4 million?
Mike Winkelmann, known as Beeple.
What is the main weakness of blockchain technology?
It relies on proof of work, which is an inefficient form of database requiring significant energy.
What is proof of stake?
An approach where one computer is chosen from a small, trusted group to solve the proof of work problem.
What are the two historical purposes of money?
- Medium for exchange
- Store of value
What did Sumerian barley represent in ancient trade?
A form of money that all other transactions were priced in.
What is a characteristic of today’s national currencies?
They are trusted to have value because of societal belief and legal tender laws.
What is bitcoin?
A cryptocurrency that introduced the concept of blockchain databases.
Fill in the blank: Bitcoin miners solve the _______ problem.
[proof of work]
As of March 2021, how much electricity did bitcoin miners consume?
More electricity than Argentina.
What is the maximum number of bitcoins that can ever exist?
21 million.
What is one way bitcoin is used in commerce?
To make payments, such as purchasing Tesla electric cars.
What is Dogecoin?
A cryptocurrency started as a fun and easier alternative to bitcoin.
What is Ethereum used for?
To record many different transactions using its own digital currency.
What is the proposed currency by Facebook called?
Libra.
What is a potential impact of cryptocurrencies on national governments?
They could lose the ability to print money, a process known as seigniorage.
True or False: Cryptocurrencies currently make up a significant portion of global payments.
False
What is the main impact of cryptocurrencies so far?
To create a speculative asset class.
What energy problem does the blockchain face?
High energy consumption due to proof of work.
