Week 4 Flashcards
What has happened to number of residential loans in the last years
They have decreased over the last years
What is happening to the buy-to-let as share of a portfolio of real estate
it is declining
What is credit risk?
Risk that a contracted payment is not going to be paid to a borrower
Who puts a price on the risk
the market and it is built into the market purchase price
What is the credit spread
Part of the price that is due to credit risk
What do typical models that banks and financial institutions use to model risk contain?
- Conditions of the general economy and those of the specific firms as inputs
- It generates the credit risk as outputs
How to get the estimate of the amount of economic capital needed to support credit risk activities
Banks use an analytical framework that relates required economic capital for credit risk to their portfolio’s probability distribution function of credit losses.
Mechanisms for allocating economic capital against credit risk assume that the shape of pdf can be approximated by distributions that could be parametrised by mean and standard deviations of what?
portfolio losses
What are the 2 components of credit risk?
Expected loss: amount of credit loss the banks expects to experience in it’s credit portfolio over it’s horizon
Unexpected loss: measure of the bank’s risk in its credit portfolio
What is the std. dev. of the credit loss PDF and what is it used for?
average deviation of expected losses it is used to measure unexpected loss
What is stress loss?
if the sum of expected loss and unexpected loss shows bank can’t meet it’s credit obligation and profit. This is represented by stress loss.
What 2 problems that banks have to overcome to mamange credit risk
- adverse selection
- moral hazard
What are the 5 principals banks use to manage credit risk and tell what each principal entail
1) Screening and monitoring
- screening, monitoring and enforcement
2) Long-term customers
- reduces cost of information collection
- easier to screen bad credit
3) Loan comitments
- promotes long term relations
- good for information gathering
4) Collateral and compensating balances
- property promised if borrower defaults
5) Credit rationing
- Lender refuses loan for any amount no matter what rate
- Lender willing to loan less than borrower would like
What does a bank’s balance sheet contain for assets and liabilities + equity
How does interest rate changes and volatility affect financial institutions
What is gap analysis
method of measuring the sensitivity of a bank’s profit to changes in interest rates
What is Basic gap analysis
amount of rate sensitive liabilities subtracted from amount of rate sensitive assets multiplied by change in interest rates
What is maturity bucket approach?
Measures the gap for several maturity subintervals called maturity bucket
what is standardised gap analysis
Account for different degrees of rate sensitivity among rate sensitive assets and liabilities
What is duration analysis and it’s formula
measures the sensitivity of the market value of the bank’s total assets and liabilities to change in interest rates.
What does the duration analysis use and what is it based on?
Macaulay’s concept of duration which uses the weighted average duration of a financial institution’s assets and of it’s liabilities to see how net worth responds to a change in interest rates.
What do both gap and duration analysis suggest happens to banks if interest rates rise?
they suffer only if rate sensitive liabilities are more than assets
What do both gap and duration analysis suggest happens to banks if interest rates fall?
they gain only if rate sensitive liabilities are more than assets
If a bank is subject to substantial interest rate risk, how can it eliminate intrest rate risk?
- Shortening duration of assets
- Lengthen the duration of its liabilities
What are off balance sheet activities?
They generate income but do not appear on balance sheet
Give examples of off-balance sheet activities
- loan sales
- generation of fee income
- trading activates and risk management techniques: financial futures, options for debt,
What are internal controls to reduce the principal-agent problem
- Separation of trading activities and bookkeeping
- Limits on exposure
- Value-at-risk
- stress testing
What are climate risks classified into?
- Physical risks: landslides, floods, wildfires storms etc.
- Transition risks: related to process of adjustment to low carbon economy
What are climate risk driver?
- Physical risks
- Transition risks
How do the financial risks from climate risk drivers arise
What is the linkage between climate, economy & financial stability
What are the risks that bank’s face and how they manage them?
