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Banking > Week 8 - Bank Management > Flashcards

Week 8 - Bank Management Flashcards

1
Q

Risks must be…

A
  1. Identified
  2. Measured
  3. Managed
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2
Q

What are the major risks for banks?

A
  1. Credit risk
  2. Market risk
  3. Interest rate risk
  4. Liquidity/funding risk
  5. FX risk
  6. Country & sovereign risk
  7. Operational risk
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3
Q

What interests must be balanced in risk management?

A
  • Regulators want less risk
  • Shareholders want more risk
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4
Q

How are losses covered?

A
  • Expected loss covered by LLP
  • Unexpected loss covered by capital
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5
Q

What is the banking book?

A

Assets expected to be held to maturity

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6
Q

What is the trading book?

A

Securities / loans held for sale

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7
Q

What are a bank’s two books?

A
  • Banking book
  • Trading book
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8
Q

What is PD?

A

Probability of default (for this year / 90 days – discretionary)

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9
Q

What is included in credit risk?

A
  • Failure to pay
  • Credit rating downgrades
  • Any failure to meet obligations
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10
Q

What is LGD?

A

Loss given default (% of exposure lost in event of default – e.g. will we recoup some from selling the collateral?)

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11
Q

What terms are important in measuring credit risk?

A
  • PD
  • LGD
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12
Q

How is credit risk calculated?

A
  • Historical data where possible
  • Statistical models otherwise
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13
Q

What are some traditional measures of credit risk?

A
  • Total loans/total assets
  • NPL/total loans
  • Loan losses/total loans
  • Loan loss reserves/total assets
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14
Q

What are some additional measures of credit risk?

A
  • Loan concentration
  • Rapid loan growth
  • High lending rates
  • Loan loss reserves/NPLs
  • Total loans/total deposits
  • NPLs/deposits
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15
Q

What is loan concentration?

A

Lending to one region/industry

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16
Q

What is market risk?

A

Losses arising from movements in market price

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17
Q

Where is market risk most relevant?

A
  • Universal banks
  • Arises from trading book
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18
Q

What is interest rate risk?

A

Unexpected rate changes affect earnings or market value

19
Q

What causes interest rate risk?

A

Mismatch between fixed-rate vs rate-sensitive assets & liabilities

20
Q

What is the strategic variable for banks?

A

Interest rates – they compete by charging lower/paying higher

21
Q

What are the types of interest rate risk?

A
  • Refinancing risk
  • Reinvestment risk
22
Q

When is refinancing risk relevant?

A

When assets are more long-term than liabilities

23
Q

When is reinvestment risk relevant?

A

When liabilities are more long-term than assets

24
Q

What is the danger in refinancing risk?

A

Interest rates rise

25
Q

What is the danger in reinvestment risk?

A

Interest rates fall

26
Q

What is another name for liquidity risk?

A

Funding risk

27
Q

What are the types of liquidity risk?

A
  • Day-to-day (managed by interbank lending)
  • Liquidity crisis
28
Q

What can FX risk affect?

A
  • Assets
  • Liabilities
  • Off-balance sheet activities
  • Banking & trading books
29
Q

How can FX risk manifest?

A
  • Make a loan in a foreign currency
  • That currency depreciates
  • You lose value
30
Q

What is country risk?

A

Economic / social / political conditions keep borrowers from paying

31
Q

What is sovereign risk?

A

Risk of government default

32
Q

What is an example of sovereign risk?

A

Greek sovereign debt crisis in 2011 / defaulting on €1.6b to the IMF in 2015

33
Q

What causes operational risk?

A
  • External events
  • Internal process / people / systems
34
Q

What are examples of operational risks?

A
  • Internal / external fraud
  • Workplace safety
  • Damage to physical assets
  • Natural disasters / business disruption
  • Technology / cyber risk
35
Q

What is the only type of risk that should be fully hedged, and why?

A

Operational risk cannot increase profit

36
Q

Why is operational risk difficult to measure?

A

Events are rare but severe

37
Q

What are examples of miscellaneous risks?

A
  1. Off-balance sheet risk
  2. Capital risk
  3. Counterparty risk
  4. Conduct risk
  5. Reputational risk
38
Q

What happens when risks are aggregated?

A

The collective Value at Risk of all traders is greater than the sum of its parts

39
Q

What are examples of risk interrelation?

A
  • Any crisis comes with reputational risk
  • Macro cycles affect both interest rates + default rates
40
Q

What are some risk mitigation techniques?

A
  1. Guarantees to reduce LGD
  2. Derivatives to hedge & reduce volatility
  3. Insurance to reduce operational risk
41
Q

What is one ongoing trend in risk management?

A

It’s getting more expensive to insure against climate risk

42
Q

How can market-based funding increase liquidity risk?

A

Market liquidity can rapidly disappear

43
Q

How can diversification be applied to loan portfolios?

A

e.g. 0.01% of funds per borrower

Banking (10 decks)

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