Deck 20: Capital Adequacy

Question 1

The market value of capital is equal to market value of assets minus the market value of liabilities.

Answer 1

True

Question 2

An FI may be insolvent in market value terms even if the book value of equity is positive.

Answer 2

True

Question 3

Protecting FI insurance funds in the event of an FI failure is the responsibility of taxpayers.

Answer 3

False

Question 4

The primary role of capital for an FI is to assure the highest possible return on equity for its shareholders.

Question 5

The book value of bank equity is the present value of assets minus the present value of liabilities.

Question 6

The book value of bonds and loans reflects the market value of those assets when they were placed on the books of an FI.

Question 7

If the value of equity is less than zero on a mark-to-market accounting basis, liquidation of the FI may result in losses to the depositors or creditors.

Question 8

One function of bank capital is to protect uninsured depositors, bondholders, and creditors in the event of insolvency and liquidation.

Question 9

The book value of equity is seldom equal to the market value of equity.

Question 10

The economic definition of the value of an FI's equity is the book value of assets minus the market value of liabilities.

Question 11

Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.

Question 12

One function of capital is to provide funding for real assets, such as branches and technology that are necessary to provide financial services.

Question 13

Under Generally Accepted Accounting Principles, FIs have flexible rules in recognizing the amount and timing of loan losses.

Question 14

The function of capital to serve as a source of funds is critical to regulators in setting risk-based deposit insurance premiums.

Question 15

Market value of equity is more appropriate than book value of equity at reflecting changes in the credit risk and interest rate risk of an FI.

Question 16

If the value of equity is less than zero on a mark-to-market accounting basis, liquidation of the FI would result in losses to the shareholders.

Question 17

When a substandard loan is identified by a regulator, it is required that the loan immediately be charged off by the bank.

Question 18

Except in cases of extreme credit risk shocks or interest rate risk shocks, the book value of equity is equal to the economic or market value of equity.

Question 19

If an FI were closed by regulators before its economic net worth became zero, neither liability holders nor those regulators guaranteeing the claims of liability holders would stand to lose.

Question 20

Capital is the primary protection for an FI against the risk of insolvency and failure.

Question 21

Market value accounting is likely to increase the variability of earnings of an FI.

Question 22

Under Basel III, Tier I capital measures the market value of common equity plus the amount of perpetual preferred stock plus minority equity interest held by the bank in subsidiaries minus goodwill.

Question 23

The leverage ratio specified under FDICIA does not account for the risks of off-balance-sheet activities.

Question 24

More frequent regulatory examinations and stricter regulator standards will cause greater discrepancies in book value of equity and the market value of equity.

Question 25

The implementation of true market value accounting for FIs may have adverse effects on small business finance and economic growth because of the hesitancy of FIs to invest in long-term assets.

Question 26

FDICIA required that banks and thrifts adopt the same capital requirements.

Question 27

Under FDICIA, the ability for regulators to show forbearance is limited by a set of mandatory actions for each level of capital that an FI achieved.

Question 28

Market value accounting often is said to be difficult to implement because of the amounts of nontraded assets.

Question 29

The Tier I leverage ratio measures the amount of an FI's total capital relative to total assets.

Question 30

Under Basel III a depository institution's capital is divided into five categories.

Question 31

Under FDICIA, regulators are required to take prompt corrective action steps when a DI falls outside of Zone 1.

Question 32

Basel I (1993) requires banks in the member countries of the Bank for International Settlements to utilize risk-based capital ratios.

Question 33

Market value accounting often is criticized because the error in market valuation of nontraded assets likely will be greater than the error using the original book valuation.

Question 34

It is likely that the discrepancy between book value of equity and market value of equity will increase as volatility in interest rates increases.

Question 35

The SEC requires securities firms to follow capital rules that utilize market value accounting.

Question 36

Basel III capital ratios were enacted due to Basel II weaknesses exposed during the financial crisis of 2008-20009.

Question 37

Book value accounting systems recognize the impact of interest rate problems sooner than credit risk problems.

Question 38

Under Basel II (2006), total capital is equal to Tier I capital plus Tier II capital.

Question 39

Basel III capital ratios will become fully effective in 2016.

Question 40

The greater the Tier I leverage using the Standardized Approach under Basel III, the more highly leveraged the bank.

Question 41

Under Basel III, banks are allowed to use their internal estimates of borrower creditworthiness to assess credit risk subject to strict disclosure standards.

Question 42

Under Basel III, the credit risk-adjusted value of the bank's on-balance-sheet assets can be found by adding the products of the risk weights for each asset times the market value of each asset.

Question 43

Under Basel III, banks must hold a total capital to credit risk-adjusted assets equal to 8 percent to be adequately capitalized.

Question 44

In addition to establishing minimum capital requirements, Basel II proposed procedures to ensure that sound internal process are used to assess capital adequacy and to set targets that are commensurate with the risk profile and environment.

Question 45

Basel II attempts to encourage market discipline by having banks disclose capital structure, risk exposures, and capital adequacy in a systematic manner.

Question 46

The determination of risk-adjusted on-balance-sheet assets under Basel III requires the segregation of assets into nine categories of credit risk exposure.

Question 47

Counterparty credit risk is more prevalent for exchange-traded derivatives than over-the-counter (OTC) contracts because the bank has more control of its OTC contracts.

Question 48

Under Basel II (2006), regulatory minimum capital requirements for credit, market, and operational risks are covered in the first pillar of the regulation.

Question 49

Similar to Basel II, Basel III will require banks to assign on-balance-sheet assets to one of four categories of credit risk exposure.

Question 50

In determining the risk-adjusted value of the on-balance-sheet credit equivalent amounts of the contingent guaranty contracts, the risk weights are determined by the credit rating of the underlying counterparty of the off-balance-sheet activity.

Question 51

The evaluation of credit risk of off-balance-sheet (OBS) assets under Basel III requires that the notional amount of OBS items be converted to credit equivalent amounts of on-balance-sheet items.

Question 52

In evaluating the risk-adjusted asset value of foreign exchange forward contracts, the value of the current exposure can be either positive or zero.

Question 53

The risk-adjusted asset values of OBS market contracts or derivative instruments are determined in a manner similar to the risk-adjusted asset values of contingent guarantee claims.

Question 54

Under Basel II (2006), operational risk can be measured by four different approaches.

Question 55

Counterparty credit risk is the risk that the other party of a contract will default on contract obligations.

Question 56

As compared to Basel I, the standardized approach of Basel III is designed to produce capital ratios that are more in line with the actual economic risks that the DIs are facing.

Question 57

Basel III guidelines for determining credit risk-adjusted on-balance-sheet assets relies more heavily on credit agency ratings than did Basel I.

Question 58

The use of risk-based capital measures under Basel I (1993) effectively mark-to-market the bank's on- and off-balance-sheet for the purpose of reflecting credit and market risk.

Question 59

Determining risk-adjusted asset values for OBS market contracts requires multiplying the notional values by the appropriate risk weights.

Question 60

Under Basel III, OBS contingent guaranty contracts are assigned the same risk weights as on-balance-sheet principal items to determine their risk-adjusted asset values.

Question 61

In the life insurance model, morbidity risk differs from mortality risk by the circumstances surrounding the actual death event.

Question 62

Under market value accounting methods, FIs

A)must write down the value of their assets to fully reflect market values.
B)have a great deal of discretion in timing the write downs of problem loans.
C)must conform to regulatory write-down schedules.
D)have an incentive to fully reflect problem assets as they become known.
E)are required to invest in expensive computerized bookkeeping systems.

Question 63

The Basic Indicator Approach in calculating capital to cover operational risk requires banks to hold 12 percent of total assets in capital to cover operational risk exposure.

Question 64

Losses in asset values due to adverse changes in interest rates are borne initially by the

A)equity holders of an FI.
B)liability holders of an FI.
C)regulatory authorities.
D)taxpayers.
E)insured depositors.

Question 65

Through August 2012, which of the following approximates the amount of dividends and assessments that the U.S. Treasury has received from entities participating in the TARP Capital Purchase Program?

A)$2.1 billion.
B)$1.2 billion.
C)$12.2 billion.
D)$16.0 billion.
E)$26.25 billion.

Question 66

Operational risk has increased to a point that the Bank for International Settlements (BIS) will require DIs to account for it in the capital adequacy standards under Basel II.

Question 67

A life insurance company that is a parent company is not required to hold an equivalent amount of risk-based capital to protect against financial downturns of affiliates.

Question 68

In the property-casualty insurance model, risk-based capital is a function of six different risk categories.

Question 69

A deficiency of the risk-based capital ratio is that it measures the ability of a bank to meet both the on- and off-balance-sheet credit risk, but not the interest rate or market risks.

Question 70

Each of the following is a function of capital EXCEPT

A)funding the branch and other real investments to provide financial services.
B)protecting the insurance fund and the taxpayers.
C)assuring the highest possible return on equity for the shareholders.
D)protecting uninsured depositors in the event of insolvency and liquidation.
E)absorbing losses in a manner that allows the FI to continue as a going concern.

Question 71

The Standardized Approach in calculating capital to cover operational risk requires DIs to separate activities into business units from which a capital charge is determined based on the amount of operational risk in each unit.

Question 72

Through August 2012, which of the following approximates the amount of funds paid back to the U.S. Treasury as part of the TARP Capital Purchase Program?

A)$192 billion.
B)$120 billion.
C)$234 billion.
D)$26 billion.
E)$19 billion.

Question 73

Regulatory-defined capital and required leverage ratios are based in whole or in part on

A)market value accounting concepts.
B)book value accounting concepts.
C)the net worth concept.
D)the economic meaning of capital.
E)None of the above.

Question 74

In the life insurance model, the ratio of total surplus and capital to the risk-based capital calculation must be greater than or equal to 1.0 for the insurance company to be satisfactorily capitalized.

Question 75

The difference between the market value of assets and liabilities is the definition of the

A)accounting value of capital.
B)regulatory value of capital.
C)economic value of capital.
D)book value of net worth.
E)adjusted book value of net worth.

Question 76

The capital requirements for broker-dealers include a net worth market value to assets ratio of at least 2 percent.

Question 77

Broker-dealers make very few adjustments to the book value net worth to reach an approximate market value net worth.

Question 78

The risk-based capital model in the life insurance industry includes asset risk, business risk, insurance risk, and interest rate risk.

Question 79

The risk-based capital ratio fails to take into account the effects of diversification in the credit portfolio.

Question 80

The risk-based capital ratio does account for loans made to companies with different credit ratings.