Term
| On a bank's balance sheet, Assets=Deposits and Loans=Liabilites. True or False and why? |
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Definition
1. False. Loans are assets because their the banks money and deposits are liabilities because they are the customers money
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Term
| What are the three basic roles capital performs in a bank? |
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Definition
The 3 basic roles of capital are:
a. Regulatory requirements for safety and soundness
b. Protection against credit loss and other losses
c. Fuel to enable growth. (p.s.well capitalized is 10% risk weighted capital)
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Term
| What primary economic functions does a bank perform? |
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Definition
Economic functions of a bank are
a. Deposit services (financial intermediary, cash repository, fiduciary responsibility)
b. Credit services(implement gov. policy with regard to interest rates, create money/multiplier effect, make loans, guarantor of credit)
c. Payment services(pay checks, issue credit cards, provide electronic channels, transfer funds)
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Term
| What are some examples of things a bank's management team could/should do to ensure it was meeting its responsibilities in the area of Control? |
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Definition
The control responsibility includes controlling
a. Budgets
b. Key Performance Metrics
c. Compensation Plans(who gets rewarded for what?)
d. Policies/Procedures
e. Corporate culture
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Term
| Based on what you learned in this class, what do you feel are the primary risks a bank faces and what can the bank do to mitigate those risks? |
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Definition
Primary risks are:
a. Concentration Risks
b. Credit Risks (most likely to cause a bank failure. Don’t be to risky)
c. Liquidity Risks (run on the bank scenario)
d. Interest Rate Risks: The risk that interest rates will change over time./Need to hedge
i. Degree of change
ii. Speed of change
iii. Volatility of change(how often)
e. Risk Mitigation: Strong management team, establish a culture where everyone is a risk manager, policies/procedures, internal controls, effective ALCO committee
f. Financial Practices: Capital and reserves, hedges, swaps, options, diversification, audits, insurance
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Term
| If you were charged with creating a key metrics scorecard for a bank's senior management team on which their incentive comp/bonus was going to be based, which metrics would you include and why? |
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Definition
I would include 3 main things.
a. Amount of loans being produced
b. Overall risk quality of loan portfolio
c. Net interest margin above a certain level
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Term
| What typically is the primary generator of a banks profitability and what are its two key components? |
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Definition
Primary generator of a banks profitabilty is its Net Interest Margin. This is made up of interest income and interest expense
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Term
| Of the two components that make up Net Interest Margin, which is, arguable the most important and why? |
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Definition
1. Interest Income from loans, interest expense from deposit: Interest expense is most important because it can be change in these rates affect a greater number of deposits as oppose to a single rate on a loan
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Term
| Checking accounts are arguably the most important of all deposit accounts. True or False? |
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Definition
1True. Checking accounts are the most important of deposit accounts because:
a. Most people identify their primarily banks with their active DDA accounts
b. DDA accounts are extremely sticky. Huge hassel factors in changing banks
c. DDA accounts give you the best option to cross sell other products/services/loans
d. DDA accounts have no or little interest. Lowest cost of funds in the bank
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Term
| Checking accounts are typically considered to be the least expensive of all funding sources at a bank. True or False and why? |
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Definition
A case can be made there are not to least expensive because:
a. Higher operating costs
b. Lots of ancillary costs
c. High touch.
d. Dodd frank act makes interest payments on dda account legal
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Term
| What is the minimum amount of capital a bank needs to maintain to be considered "well capitalized"? |
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Definition
Well capitalized is 10% risk weighted capital. Now days 12% is more the norm
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Term
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Definition
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Term
| The primary distinguishing characteristic of a commodity is its ______. What is, arguably, the most" commoditized" of all basic banking products and why? |
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Definition
1. The primary distinguishing characteristic of a commodity is its high price sensitivity, very interchangeable between other banks. Residential mortgages are highly commoditized
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Term
| What is deposit insurance? Who pays for it? How are premiums determined? Who adminsters the Deposit Insurance Fund? How much is each account insured to? Who "backs" the fund? |
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Definition
1. Deposit insurance protects depositors against bank failures
a. Banks pay premiums based on risk profile
b. Deposit Insurance Fund is run by FDIC, backed by the full faith and credit of US gov
c. Backed for $250,000
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Term
| What is Interest Rate Risk and what are its primary components? |
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Definition
1. Interest Rate Risks: The risk that interest rates will change over time./Need to hedge
a. Degree of change
b. Speed of change
c. Volatility of change(how often)
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Term
| Why is mitigation of Interest Rate Risk so important to a bank? |
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Definition
IRR mitigation is so important because a bank’s largest portion of revenue and expense are based on interest rates. Directly affects NIM.
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Term
| What does it mean if a bank is considered to be "liquid"? |
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Definition
If a bank is liquid that means that it has access at a reasonable cost, to cash in the exactly the amount required at precisely the time needed.
a. Popular liquid assets are: T-bills, Fed funds, CD’s,etc
b. Liquidity is important for
i. Primarily: customers withdrawing funds and for demand for loans
ii. Secondarily: Pay off previous borrowings that have matured and pay dividends/income taxes
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Term
| Why, arguably, is a bank's asset liability managment committee(ALM) the most important operating committee in the bank? |
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Definition
ALM committees are important because
a. Establish funding, lending, and investment plans to keep bank within risk exposure limits
b. Monitors competitive rates and peer performance
c. Sets pricing for loans and deposits
d. Manages IRR risks:
i. Manage interest sensitivity gap of a bank
ii. A defensive strategy would be to keep maturity gap closer to zero, so as not to be affected by interest rate change
iii. Go for a positive gap if they expect interest rates to rise (interest IS assets, decrease IS liabilities) vice versa
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Term
| You are a relatively inexperienced loan officer thats just been asked to cosnsider whether to renew a companies $300,000 line of credit for the upcoming year. Which of the many 'Cs' of credit are you most likely to place your emphasis on and why? |
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Definition
The first thing I would consider in whether or not to renew their LOC is look at their character. This is comprised of things such if the customer is driven and dependable to repay a loan. Most likely would look at past behavior to judge this. Secondly I would look at their capacity to pay back loan. This is seeing if a borrower is financially capable to pay back a loan, such as looking if there is adequate cash flow for the borrower(during normal and even difficult business cycles)
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Term
| what is the difference between a revolving loan and an installment loan? what is difference between a direct loan and an indirect loan? give examples |
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Definition
1. Revolving Loans vs Credit Loans/ Direct Loan vs Indirect Loan
a. Revolving loans: Apply once; balances can increase as line is drawn upon, reduced as line is paid back.(credit cards)
b. Installment Loan: Apply each time a loan is needed. Balances decrease based on fixed payments that are scheduled over a defined term.(car loans)
c. Direct Loan: loans made directly to the borrower
d. Indirect Loan: loans referred to a bank by a dealer(auto dealer)
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Term
| What does it mean to "perfect" collateral and why is it important to the lender? |
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Definition
1. This is through UCC filing that incase the borrower defaults then the lender will have 1st position to the listed collateral. Important to a lender because if collateral is not perfected, then another lender might have first dibs on the collateral
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Term
| Why is it as important to review loans that are in the loan portfolio after they have been made as it is to review them during the process of making them? |
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Definition
It is important to monitor loans after they’ve been made to look out for any issues that might arise. This includes
a. Credit Risk: Erosion of borrowers financial capacity, ex. Cash flows
b. Concentrations: How the overall market is doing, ex. Residential mortgage industry going down hill
c. Erosion of collateral value
d. Loan Portfolio Risk Mitigation
i. Current financial status of borrower, personal finance statements, tax returns
ii. Annual property updates: physical inspection to check condition
iii. Inventory inspection: Work in process, finished goods, flooring review
iv. Internal and external credit review: files current, no credit and collateral degradation
v. Monitoring covenants
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Term
| Fill in the blanks: It's the ____ of the lending over the ____ of the lending." Lewis Preston |
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Definition
It’s the quality of lending over the quantity of lending.” Lewis Preston
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Term
| When a bank refers to a borrower's "character" what are they focused on? |
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Definition
Borrower character:
a. Is the customer driven to repay the loan?
b. Borrower ethical and honest
c. Trustworthy
d. Dependable
e. Warning: Can be seen as too subjective and potentially discrimmatory
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Term
Define:
Credit Risk
Interest Rate Risk
Liquidity Risk
Concentration Risk |
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Definition
a. Credit Risk: The risk associated with a borrowers overall ability to pay back a loan. If the borrower has a higher chance of defaulting such as future cash flows are unsure, then credit risk will be higher
b. Interest Rate Risk: The risk associated with potential changes in interest rates. Changes in interest rates can negatively affect the value of loans that are
c. Liquidity risk: The risk arising from a bank’s inability to meet its obligations when they come due without incurring unacceptable losses. Ex. A bank needs to borrow expensive funds to pay back short term liabilities. Worst case scenario: Run on the bank
d. Concentration risk: Risk associated with having high amount of the loan portfolio in one economic market. Ex. Liberty bank in residential mortgage industry
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