Deck 6: The Stability of Deposit-Taking Institutions

Question 1

ADIs will manage market risks by individually hedging each exposure with derivatives.

Answer 1

False

Question 2

The GFC arose out of very poor management of credit risk in the US housing loan market.

Answer 2

True

Question 3

An 'impaired asset' is a loan on which loan payments are 90 days overdue and a 'non-performing loan' is one which the bank will foreclose.

Answer 3

False

Question 4

Prudential supervision by APRA only applies to ADIs.

Question 5

A bank's capital serves to protect depositors' funds in the event of losses by the bank.

Question 6

ADIs conduct stress tests to ensure they can maintain liquidity should extreme events occur.

Question 7

Losses incurred by a rogue trader are classified as an operating risk.

Question 8

The essential characteristic of capital (under the CAR)is that payments to depositors take priority over payments to the suppliers of capital.

Question 9

The CAR encourages banks to hold assets in the lower-risk categories.

Question 10

Ordinary shares are the most common type of financial instrument used for hedging.

Question 11

Banks are financially stable when they maintain profitability and liquidity.

Question 12

Liquidity risk is the main risk faced by ADIs.

Question 13

An ADI that has borrowed on a fixed-rate basis and lent on a floating-rate basis is exposed to interest rate risk.

Question 14

Maturity mismatch implies that Australia's banks have a serious liquidity management problem.

Question 15

Under the capital adequacy requirement (CAR), banks are required to hold at least 8 per cent of their deposits with the RBA so that they can meet their obligations to depositors.

Question 16

APRA is responsible for protecting depositors' funds.

Question 17

Funding risk can be eliminated by maintaining a good credit rating.

Question 18

Banks may face losses as a result of events that are beyond their control.

Question 19

ADIs face many risks and are therefore a risky place for depositor's funds.

Question 20

Banks manage their credit risk through prudent lending practices.

Question 21

The CAR is the primary form of prudential supervision, whereas efforts by APRA to ensure ADIs are capable of identifying and managing their risks are of secondary importance.

Question 22

What is the main risk faced by ADIs?

A)Liquidity risk
B)Funding risk
C)Credit risk
D)Market and interest rate risks
E)Operating risk

Question 23

The RBA's function as lender of last resort means it is able to bail-out banks that are too-big-to-fail in order sustain financial system stability.

Question 24

The RBA monitors the bank's capital ratios, liquidity ratios and executive remuneration packages as part of their regular Financial Stability Review.

Question 25

Under Basel II banks are required to ensure that their capital exceeds 8 per cent of their risk-weighted assets.

Question 26

The principal means by which banks manage their credit risk exposures is through:

A)credit derivatives
B)charging high interest rates for high risk borrowers
C)securitisation
D)investing most of their funds in low risk government securities
E)prudent lending practices

Question 27

The maturity mismatch between an ADI's liabilities and assets gives rise to:

A)iquidity and funding risks
B)credit risk
C)market risk
D)interest rate risk
E)operating risk.

Question 28

The quality of bank loans is of fundamental importance to the health of the banking system.

Question 29

APRA prudentially supervises authorised deposit-taking institutions having regard to the Basel Committee on Banking Supervision (BCBS).

Question 30

For the major banks in Australia the main risks faced during the GFC were:

A)credit and market risks
B)market and operating risks
C)operating and liquidity risks
D)liquidity and funding risks
E)funding and credit risks.

Question 31

Basel III is a set of reforms that aim to increase the financial strength and resilience of internationally active banks.

Question 32

The share market and ratings agencies provide an assessment as to the condition and prospects of financial institutions.

Question 33

Basel III introduces new liquidity requirements on banks.

Question 34

The GFC caused substantial losses for the major Australian banks.

Question 35

Of the following, which risk is most likely to be managed with the use of derivative contracts?

A)Liquidity risk
B)Funding risk
C)Credit risk
D)Market and interest rate risks
E)Operating risk

Question 36

Basel III increases bank's capital requirements by raising the amount of 'tier 2' capital banks are required to hold.

Question 37

The RBA examines a number of key indicators for the purpose of reviewing financial stability.

Question 38

Funding risk is best defined as:

A)the risk of an ADI being unable to meet their financial obligations as they fall due
B)the risk the ADI will not be able to settle their payment system obligations
C)the risk of an ADI loss resulting from a borrower failing to make its agreed loan payments
D)the risk that the ADI cannot continue to fund their assets, such as the inability to roll-over maturing debts
E)the chance of losses arising from unexpected movements in a market variable.

Question 39

Which of the following is NOT fundamental to the financial stability of banks?

A)Their profitability
B)Their liquidity
C)Their holding adequate equity funds
D)Their access to alternative funding sources
E)All of these are fundamental to a bank's financial stability.

Question 40

The principal roles of an ADI's management team include:

A)to grow the business as quickly as possible
B)to provide its depositors with a safe place for their funds
C)to make the highest return possible for shareholders
D)to avoid taking any risks
E)All of these.

Question 41

Which of the following international organisations has responsibility for promoting cooperation between central banks?

A)The Bank for International Settlements (BIS)
B)The Basel Committee on Banking Supervision (BCBS)
C)The International Monetary Fund (IMF)
D)The Financial Stability Board (FSB)
E)The Federal Reserve

Question 42

Who is responsible for the prudential supervision of Australia's financial institutions?

A)The Reserve Bank of Australia (RBA)
B)The Federal Treasury
C)The Australian Prudential Regulation Authority (APRA)
D)The Australian Securities and Investments Commission (ASIC)
E)The Commonwealth Bank of Australia

Question 43

Basel III's reforms to bank liquidity requirements do NOT require banks to:

A)hold increased balances in their exchange settlement accounts
B)increase their holdings of high-quality liquid securities
C)be able to cover their net cash outflows for at least 30 days in the event the financial markets cease to function
D)make greater use of 'stable' funding sources
E)increase their holdings of government securities.

Question 44

The amount of non-performing loans is most relevant to which of the following key indicators monitored by the RBA?

A)Profitability
B)Asset quality
C)Capital
D)Liquidity
E)Share-prices

Question 45

Operating risk is:

A)the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events
B)the chance of loss arising from movements in market variables
C)the possibility of an ADI being unable to meet its financial obligations as they fall due
D)the risk of a borrower defaulting on their scheduled loan payments
E)the risk that an ADI cannot maintain sufficient funds to cover its loans.

Question 46

Profitability is an important indicator of the financial stability of an ADI because:

A)it is a direct indicator of financial viability
B)losses by an ADI can result in substantial withdrawals by their depositors
C)losses by an ADI can trigger a run on similar institutions.
D)All of these.
E)None of these.

Question 47

When fully implemented, Basel III will increase the quantity and quality of capital held by banks by:

A)decreasing the CAR but increasing the amount of 'tier 1' equity capital
B)decreasing the CAR but increasing the amount of 'tier 2' equity capital
C)increasing the CAR and the amount of 'tier 2' equity capital
D)increasing the CAR and the amount of 'tier 1' equity capital
E)increasing the CAR and the amount of 'tier 1' and 'tier 2' equity capital.

Question 48

The RBA's responsibility for financial system stability is carried out in a number of ways.These do NOT include:

A)influencing the rate of economic activity and inflation through monetary policy
B)ensuring the payments system is sound
C)acting as lender of last resort to the banking system
D)being prepared to bail-out institutions that are 'too-big-to-fail'
E)regularly reviewing the stability of the domestic and global financial systems.

Question 49

The primary protection against the risk of ADI insolvency in Australia is:

A)the CAR (capital adequacy requirement)
B)the effective management by banks of the risks they face
C)monitoring by the Reserve Bank (Australia's central bank)
D)monitoring by APRA (Australia's prudential regulator)
E)access to an active money market.

Question 50

Comment on the general performance of loans made by Australian banks.

Question 51

Describe maturity mismatch and identify and explain the risks it raises for ADIs.

Question 52

Prudential supervision of ADIs in Australia:

A)is required as deregulation of financial systems has exposed ADIs to greater risks
B)ensures that financial institutions do not make excessive profits
C)is designed to protect shareholders
D)aims to ensure financial institutions honour their obligations to their lenders
E)aims to protect the stability of the currency

Question 53

Explain how ADIs have changed their management of funding risk post GFC.

Question 54

Describe how ADIs manage their credit risk exposure.

Question 55

The CAR requires ADI's to hold capital as a proportion of their risk-adjusted assets.The reasons for this do NOT include:

A)capital contributes to an ADIs financial strength and stability
B)capital reflects a commitment by the owners, as they face the risk of loss
C)capital can sustain solvency when an ADI makes unexpected losses
D)capital represents a reserve of funds that can be drawn on if required
E)because shareholder's face the risk of loss, capital motivates prudent behaviour by an ADI's management.

Question 56

The risk of bank losses resulting from computer fraud or cyber-attacks are examples of:

A)liquidity risk
B)funding risk
C)credit risk
D)market and interest rate risks
E)operating risk.

Question 57

Why did the government guarantee the liabilities of Australian banks during the GFC?

Question 58

An investor who bought money-market securities at a yield of 5.50% p.a.and sold the parcel a few weeks later at a yield of 5.85% p.a.would earn:

A)interest
B)a capital loss
C)a capital gain
D)interest and a capital loss
E)interest and a capital gain.

Question 59

The capital adequacy requirement specifies:

A)an ADI's minimum amount of equity capital
B)a minimum amount of liquid assets to be held by an ADI
C)a minimum amount of exchange settlement funds to be held by an ADI
D)the need to diversify lending
E)All of these.

Question 60

The 'counter-cyclical capital buffer':

A)can be imposed by APRA during periods of high credit growth in the banking system
B)form part of the Basel III reforms
C)should discourage excessive growth in risky bank assets during periods of high growth
D)is an additional equity buffer of 2.5 per cent of a bank's risk-weighted assets
E)All of these.

Question 61

Briefly describe the liquidity requirements that will apply to the major banks under Basel III.

Question 62

What is market risk? Calculate the fall in value in a $10 million parcel of 60-day money market securities when the money market yield rises unexpectedly from 5.5% to 5.75%.

Question 63

Briefly explain the aims of banking supervision and how it is carried out by APRA.

Question 64

Explain the main forms of risk faced by ADIs and discuss the risk management strategies used by ADIs to manage these risks.

Question 65

What has motivated the latest reforms to the Basel Accord (known as Basel III)? Briefly describe these reforms.

Question 66

Briefly describe each of the key indicators examined by the RBA in its Financial Stability Review.

Question 67

What is prudential supervision? Describe how APRA supervises Australian ADIs and the role of the capital adequacy requirement.

Question 68

Why is bank capital of central importance to the stability of the banking system? Explain the capital adequacy requirement and review how its implementation has changed since first being introduced.

Question 69

How has the capital adequacy requirement changed since first being developed in the 1980s?

Question 70

Explain the purpose of the capital adequacy requirement (CAR).

Question 71

Comment on the relative performance of financial regulators in the US and in Australia in recent years.

Question 72

Discuss the motivation for the introduction of the Basel Accord and for each of its revisions (i.e.Basel II and Basel III).What are the distinguishing features of each version of the Accord?

Question 73

Explain how financial crises can be triggered and the RBA's role in overseeing financial system stability.

Question 74

What is financial system stability? Explain how the RBA is able to promote system stability and its efforts to detect sources of instability.

Question 75

Present two reasons that explain how the CAR may achieve its aims.

Question 76

What is 'prudential supervision'?

Question 77

Describe two general forms of interest rate risk faced by banks.