Banking Exam

1.      Different banks in different countries have failed during different times. This shows bank failure is not an isolated episode. Why do you think bank failures happen? How would you like to explain the nature of the problems which banks encounter leading towards bank failures?

Causes of banking crises

•          (a) Macroeconomic circumstances

•          (b) Microeconomic policies

•          (c) Banking strategies and operations

•          (d) Fraud, corruption

Source: FIM – 12

2.      Give your opinion regarding the methodology or framework for having a stable and strong banking sector.

A sound banking system is one in which individual banks with most of the system's assets and liabilities:

1. efficiently intermediate financial  transactions,
2. are solvent, and
3. meet capital adequacy requirements.

Source: FIM – 13

3.      What led to the move towards Basel (II) from Basel (I)?

More comprehensive coverage

a.       Introduction of explicit capital charge for operational risk

b.      Able to capture other risks

Basel II provides banks with a menu of options for capital measurement approaches

a.       Risk sensitive approach with wider range of risk weights to reflect the true underlying risks more accurately

b.      Availability of internal ratings based approaches

Greater recognition of credit risk mitigants (Collateral, Guarantees)

Provides more pro-active role for supervisors under Pillar 2 and encourages greater market discipline under Pillar 3

Source: FIM – 05 BASEL II overview

4.      What are the important features of Basel (II)?

•         1.   Pillar One—Capital Requirements

            1.1 Credit Risk

•         1.2  Market Risk
1.3  Operational Risk

•         2.   Pillar Two                       

            2.1 Supervisory Review

            3.  Pillar Three                      

            3.1 Market Discipline

Source: FIM – 05 BASEL II overview

5.      What prompted the authorities to move to Basel (III)?

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6.      What are the important changes proposed to be made under Basel (III)?

Higher capital ratios

Use of a leverage ratio as a safety net

Tougher risk weightings for trading assets

Elimination of softer forms of capital

Exclusion of some balance sheet items from capital

Higher capital requirements for counterparty credit risks

New liquidity requirements

Contingent capital

Counter‐cyclical capital requirements

Source: FIM BASEL III Elliot

7.      What is stress testing?

• Stress testing refers to techniques used by financial institutions to analyze the effects of exceptional but plausible events in the market on a portfolio's  values.
• A stress test is a rough estimate of how the value of a portfolio changes when there are large changes to some of its risk factors (such as asset prices).
• The term rough estimate is used to avoid the perception that stress testing is a precise tool that can be used with scientific accuracy. .

Source: FIM 10 stress testing – A

8.      Why are stress testing conducted?

Stress tests help financial institutions to:

1. communicate extreme scenarios throughout the institution, thereby enabling management to take the necessary precautions (limit systems, additional capital, and so on)
2. manage risk better in more volatile and less liquid markets
3. bear in mind, during less volatile periods, that the probability of disastrous events occurring should not be neglected

Source: FIM 10 stress testing – A

9.      What can happen in stress testing’s absence?

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10.  How stress testing are conducted?

System-focused stress testing is best seen as a process:

                                                              i.      part investigative

                                                            ii.      part diagnostic

                                                          iii.      part numerical

                                                          iv.      part interpretive

Source: FIM 10 stress testing – A

11.  What value addition banks get through stress testing?

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12.  Why do you think prudential regulations are issued and also why are they called prudential regulations, rather than simply regulations?

•         So Prudential Regulations here means those regulations issued by a regulator, (who has got the authority to issue it) with a view to have a safe and sound financial system in the country. 

Source: FIM 14

13.  Explain some of the important prudential regulations which banks and financial institutions in Nepal are required to follow.

1. How much capital they must have.
2. What should be included in such Capital
3. How should their assets be classified
4. Under what circumstances banks must be required to make loan loss provision
5. How much such loan loss provision they must make
6. What should be the parameter for banks to book interest income
7. What type of risk management system banks must have
8. Should banks  be allowed or debarred from making connected lending
9. How to make sure that banks exposure is not concentrated in one borrower.
10. How to comply banks with regard to corporate social responsibility.

Source: FIM 14

14.  What are the risks which banks are required to encounter? Explain the nature and features of these risks.

1. Liquidity risk
2. Interest risk
3. Market risk
4. Credit risk
5. Off-balance sheet risk
6. Foreign exchange risk
7. Operating risk

Source: FIM 10

15.  Out of the various risks which banks have to face which one do you think banks in Nepal are very much required to face and why do you think so? How can banks manage this risk by following the standard asset liability management framework?

Operation Risk????

16.                        Why is it important for Banks to maintain Liquidity?

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17.                        What is the difference between Return On Assets (ROA) and Return On Equity (ROE)?

ROA is an indicator of managerial efficiency. It indicates how capable the management of the bank has been converting the institution’s assets into net earnings

ROE is a measure of the rate of return flowing to the bank’s shareholders. It approximates the net benefit that the shareholders have received from investing their capital in the bank  i.e. placing their funds at risk in the hope of earning a suitable profit.

Source: FIM 08

18.                        Banks have been found to be making good profit. What are the major sources of Bank Profit?

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19.                        Do you think shareholders of a bank manage to get all the net profit of a bank? Yes or No, Explain

No. 20% goes to general reserve until double + LLP

Source: class hearing

20.                        Two Banks making an identical Net Profit may not be able to give identical dividens to the shareholder. Why do you think such thing happens?

20% goes to general reserve until double + LLP

Source: class hearing

21.                        What is the meaning and importance of Maturity Bucket analysis in terms of asset liability management framework?

a.       Since assets and liabilities may be repriced at different time within the gapping period of, say, twelve months, balance sheet items can be grouped into a number of time intervals ('buckets') according to maturity/ repricing periods.

b.      Typically the buckets will have intervals of 0-30 days, 30-60 days, 60-90 days and so on.

c.       The gap for each bucket is calculated, conventionally, as the amount of rate sensitive assets less rate sensitive liabilities.

d.      However, early repayment of loans can create a gap which is difficult to quantify, and the same is true of the uncertain drawdown of loans

e.       Also, even if RSA and RSL are equal, the interest rate changes for assets and liabilities may not be of the same magnitude.

f.       Such different repricing behavior is the basis of the standardized gap which adjusts gap measures for the relative measures for the relative volatilities of various financial instruments.

Source: FIM 11

22.                        Is there any difference between any other crisis and banking crisis? If so, why? Why we need to worry more about the banking crisis?

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23. What type of financial system we have in Nepal?

Regulated by regulators

Regulated by itself

Source: FIM 1

24. What are the similarities and differences between Commercial Banks, Development Banks, Finance Companies and Micro Credit Units?

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25.   What is a Bank Balance Sheet? What are its important components?

It is a statement of a bank’s financial position (as of a specific date) listing:

a.       assets owned,

b.      liabilities owed, and

c.       owner’s equity

1.Share Capital                                  1.Cash Balance

2.Bills Payables                                  2.Balance With NRB

3.Income Tax Liabilities                  3.Balance With Other FI

XXXXXXXXXXXXXX                           4.Money At Call

4.Deposits                                                           5.Investments

5.Borrowings                                     6.Fixed Assets

6.Debentures & Bonds                  XXXXXXXXXXXXXX

7.Reserve & Surplus                       7.Loans & Advances +(BP)

8.Undistributed Dividends                            8.Non-Banking Assets 9.Other Liabilities                                                9.Other Assets  

                    TOTAL Liabilities                                 TOTAL Assets

Source: FIM 02

26.   What is the reason that in some of the bank balance sheets, we tend to see a negative figure under Retained Earning item?

LLP

27. All companies will have source and utilization of resources. For banks, what are the important sources and utilization of resources?

Deposit and Loans

28. Why do you think capital is given such an important role in the bank management?

In the first place, capital provides a cushion against the risk of failure by absorbing financial and operating losses until management can address the bank's problems and restore the institution's profitability.

Second, capital provides the funds needed to bet the bank chartered, organized and operating before deposits come flowing in.

A new bank needs starting up funding to acquire land, build a new structure or lease space, equip its facilities, and hire offers and staff even before opening day.

Third, capital promotes public confidence in a bank and reassures its creditors (including the depositors) of the bank's financial strength.

Capital also must be strong enough to reassure borrowers that the bank will be able to meet their credit needs even if the economy turns down.

Fourth, capital provides funds for the organization's growth and the development of new services, programs, and facilities.

When a bank grows, it needs additional capital to support that growth and to accept the risks that come with offering new services and building new facilities.

Most banks eventually outgrow the facilities they start with.

An infusion of additional capital will permit a bank to expand into larger quarters or building additional branch offices in order to keep pace with its expanding market area and follow its customers with convenient service offerings.

Finally, capital serves as a regulator of bank growth, helping to ensure that the individual bank's growth is held to a pace that is sustainable in the long run.

Both the regulatory authorities and the financial markets require that bank capital increase roughly in line with the growth of loans and other risky bank assets.

Thus, the cushion to absorb losses is supposed to increase along withy a banking institution's growing risk exposure.

A bank that expands its loans and deposits too fast will start receiving signals from a market and the regulatory community that its growth must be slowed or additional capital must be acquired.

Capital regulation by regulatory agencies has become an increasingly important policy tool to limit how much risk exposure banks can accept, thereby promoting public confidence and protecting the government's deposit insurance system from massive losses.

               

                Source: FIM 04

29. What is the meaning of Risk Weighted Assets?  Explain.

RWA  is a bank’s assets or off balance sheet exposures, weighted according to risk. This sort of asset calculation is used in determining the capital requirement or CAR for a financial institution. In the Basel I accord published by the Basel committee on Banking supervision, the committee explains why using a risk weight approach is the preferred methodology which banks should adopt for capital calculation.

·         It provides an easier approach to compare banks across different geographies

·         Off balance sheet exposure can be easily included in capital adequacy calculations

·         Banks are not deterred from carrying low risk liquid assets in their books

Usually, different classes of assets have different risk weights associated with them. The calculation of risk weights is dependent on whether the bank has adopted the standardised or IRB approach under the Basel II framework.

Some assets, such as debentures, are assigned a higher risk than others, such as cash or government securities/bonds. Since different types of assets have different risk profiles, weighing assets based on the level of risk associated with them primarily adjusts for assets that are less risky by allowing banks to discount lower risk assets. In most basic application, government debt is allowed a 0% risk weighting that is they are substracted from total assets for purposes of calculating the CAR.

30. Is it logical to take Off Balance Sheet activities of a bank into consideration for the purpose of calculating Risk Weighted Assets of a bank? Give reasons

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31. What are the components of Capital Fund? Explain

CORE

01.Capital Adjustment Reserve                                

02.Capital Redemption Reserve

03.Dividend Equalization Reserves

04.Irredeemable Non-cumulative preference shares

05.Other Free Reserve

06.Paid up Equity Share Capital

07.Proposed Bonus Equity Shares

08.Retained Earnings

09.Share Premium

10.Statutory General Reserves

11.Un-audited current year cumulative profit

SUPPLEMENTARY

01.Assets Revaluation Reserve                                 

02.Cumulative and/or Redeemable Preference Share   

03.Exchange Equalization Reserve                           

04.General loan loss provision                                   

05.Hybrid Capital Instruments                                   

06.Investment Adjustment Reserve

07.Other Reserves                         

08.Subordinated Term Debt

32. What are the differences between Core Capital and Supplementary Capital?

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33. What is the meaning of Capital Adequacy Ratio?

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34. How is Capital Adequacy Ratio calculated?

Basel I

Capital/Assets

Basel II

(Core Capital & Supplementary Capital)/Risk Weight (Asset +Off                                                                   Balance Sheet Exposures)

Source: FIM CAR Calculation

35.   Why is Capital Adequacy Ratio such an important parameter in bank management?

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36. What is Basel I and Basel II?

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37. What are the important differences between Basel( I) and Basel(II)?

The main difference is that Basel I accord mainly focused on capital requirement for banks. The Basel II adds supervision and market discipline to these capital requirements through the “Three Pillars” concept. The first pillar is about capital requirement. The second pillar is about regulation and supervision and the Third pillar describes market discipline.

38. What are the important differences between Basel(I I) and Basel (III)?

Basel III is an enhancement over Basel II brought out with the experience of global financial turmoil the enhancement are primarily under two heads primarily one is capital and the other is liquidity.

Capital there is a minimum prescription off capital by the way of common equity under base III. That is to say all the capital that are reckoned under basel II will not be eligible for such reckoning. Ex capital debt instrument will step up option after certain period are not eligible. Deduction from the capital was earlier considered from tier I and tier II equally. Under Basel III deductions is made from tier I capital only.

39. What is the meaning of Loan Classification? Why do you think they are undertaken in bank?

Loan classification refers to the process banks use to:

1. review their loan portfolios and
2. assign loans to categories or grades based on:

                                                               i.      the perceived risk and

                                                             ii.      other relevant characteristics of the loans.

The process of continual review and classification of loans enables banks to:

·         monitor the quality of their loan portfolios and,

·         when necessary to take remedial action:

·         to counter deterioration in the credit quality of their portfolios.

Source: FIM 06

40.How is job of Loan Classification undertaken by banks in Nepal?

                Good loan upto 90 days

                Substandard 120 days

                Doubtful 180 days

                Bad 1 yr

 41. Banks are said to be required to face deleterious affects due to the accumulation of NPAs. Why do you thinks so. Explain

Internal:

•          diversion of funds for

•          expansion / diversification / modernization

•          taking up new projects

•          helping/promoting associate concerns

•          time/cost overrun during the project implementation stage

•          business (product, marketing, etc.) failure,

•          inefficient management,

•          strained Labour relations,

•          inappropriate technology/technical problems,

•          product obsolescence, etc.

External:

•          recession,

•          non-payment in other countries

•          inputs/power shortage,

•          price escalation,

•          accidents, and natural calamities, etc.

•          changes in government policies in excise/import duties, pollution control orders, etc.,

40. Why are AMC related with bank’s NPA problem?

•          The argument for “carving out” the bad loans is that the originating bank may be less objective and may even continue lending to delinquent debtors. Furthermore, a bank preoccupied with managing bad debts may become very risk-averse, with little time or inclination for new lending. It is easier to give separate transparent goals if different people are charged with the ongoing banking operations and the resolution of bad loans. Moving bad assets off the balance sheet would also facilitate finding another bank to buy the troubled bank without complicated guarantee arrangements covering the NPLs. However, there is also a case for not moving all NPLs away from the bank. It is desirable for the bank to maintain some experience with work-out procedures. It is also unfair to the better managed banks if the distressed banks end up with no NPLs. It is important when such an approach is followed that the “bad bank” does not end up with all the “bad staff” as well as the “bad assets”. The alternative approach, is to establish a single asset management corporation to purchase NPLs from a number of banks: in effect, there will be one large “bad bank” for the whole banking industry. This seems to be becoming the predominant approach.

43. Banks have been found to be making good profit. What are the major sources of Bank Profit?

Interest income, commission n discount, exchange gain AND LOSS, NON OPERATING INCOME AND LOSS, OTHER INCOME

44. Why do you think one should not focus exclusively on Net Profit only?

46 N 47. What were the shortcomings in the Capital Adequacy Ratio regime before 1988? How these shortcomings were taken care in Basel I?

–        Aimed at

•          Strengthening stability and soundness of international banking system

•          Creating greater consistency in the assessment of internationally active banks

–        Minimum capital requirement = 8%

–        Adopted in over 100 countries worldwide

–        Refinement in 1996 to incorporate market risk

•          Several major shortcomings of Basel I have become apparent

–        Too simplistic; one size fits all approach

–        Broad-brush risk weighting structure (e.g  sovereigns based on OECD and Non-OECD classification,100% risk weight for all corporates)

–        Confined to credit and market risk

–        Provides opportunities for regulatory arbitrage

–        Seen as compliance requirement only and does not encourage good risk management practices

41.   48. Why do you think global regulators were forced to formulate Basel III?

Basel III is a set of proposed changes to international capital and liquidity requirements and some other related areas of banking supervision. It is the second major revision to an original set of rules, now known as Basel I, which was promulgated by the Basel Committee in 1988.

 THE MAJOR FEATURES OF BASEL 3 ARE :

·         Better capital quality

·         CAPITAL CONVERSATION Buffer

·         COUNTERCYCLICAL BUFFER

·         Minimun common euity and tier 1 capital requirement

·         Leverage ratio

·         Liquidity ratio

·         Systematically important  financial institutions

49 Why do you think banks are always vulnerable towards interest risk? What are the standard tools deployed by banks for managing interest risk?

IR : is the impact on banks earnings and market value of equity of changes in interest rates.

Interest Risk  (measurements)

•          Gap analysis

•          Duration analysis

•          Simulation model

50. In which way, do you think, banks will be helped in managing liquidity risk because of regulators imposing SLR (Statutory Liquidity Ratio) & CD (Credit Deposit) Ratio? What are these ratios in Nepal at the moment?

51. Why do you think, one should not hastily make conclusions based purely on Net Profit of a bank?

52. What are the prudential regulations covering Capital, Asset, Management, Earnings, Liquidity and Sensitivity? Explain

Prudential regulation

those regulations issued by a regulator, (who has got the authority to issue it) with a view to have a safe and sound financial system in the country. Issuance of such regulations for the banks and financial institutions are required because:

•          Banks play an important role in the economy

•          Their safety and soundness is very much required for a sound financial system and

•          They play with other people’s money and such money must be made safe and secure.

53. What are the consequences of accumulation of non performing assets by a bank?

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