Deck 17: Technology and Other Operational Risks

Question 1

Economies of scope refers to the:

A)fall in an FI's average costs of production as its output increases
B)increase in an FI's average costs of production as its output increases
C)situation in which the costs of joint production of FI services are higher than they would be if they were produced independently
D)ability of an FI to generate synergistic cost savings through joint use of inputs in producing multiple outputs

Answer 1

D

Question 2

Which of the following statements is true?

A)The profitability of any product innovation is negatively related to the size of the initial set-up and development costs and the FI's cost of capital.
B)The profitability of any product innovation is positively related to the size of the initial set-up and development costs and the FI's cost of capital.
C)The profitability of any product innovation is unrelated to the size of the initial set-up and development costs and the FI's cost of capital.
D)The relationship depends on the FI's individual situation.

Answer 2

A

Question 3

Which of the following wholesale services offered by FI's to businesses allows the FI to combine the email capabilities of the internet with the FI's ability to process payments electronically through the interbank payment networks?

A)electronic data exchange
B)ecommerce facilitation
C)electronic billing
D)electronic funds transfer

Answer 3

C

Question 4

The most important banking area in which technology has impacted wholesale or corporate customer services is a financial institution's ability to provide:

A)cash-management services
B)residential mortgage lending
C)issuance of certificates of deposit
D)credit approval

Question 5

Some of the most important retail payment product innovations are:

A)ATMs, EFTPOS and online banking
B)home banking, telephone banking and business-to-business ecommerce
C)online banking, smart cards and account reconciliation
D)All of the listed options are correct.

Question 6

An FI's operating cost and the efficient use of technology:

A)have no impact on the FI's profits before taxes
B)can have a significant impact on the FI's profits before taxes
C)will merely improve the FI's reputation
D)are not important as FIs have the back-up of the government in times of financial distress

Question 7

Diseconomies of scope refers to the:

A)fall in an FI's average costs of production as its output increases
B)increase in an FI's average costs of production as its output increases
C)situation in which the costs of joint production of FI services are higher than they would be if they were produced independently
D)ability of an FI to generate synergistic cost savings through joint use of inputs in producing multiple outputs

Question 8

Which of the following sources of operational risk are internally controllable by FI management?

A)technology
B)employees
C)customer relationships
D)All of the listed options are correct.

Question 9

ES account stands for:

A)exchange settlement account
B)exchange systems account
C)European settlement account
D)emerging settlement account

Question 10

Economies of scale refers to the:

A)fall in an FI's average costs of production as its output decreases
B)fall in an FI's average costs of production as its output increases
C)fall in an FI's average costs of production as its output remains stable
D)increase in an FI's average costs of production as its output increases

Question 11

How can operating expenses of an FI be reduced by improved technological efficiency?

A)By improving the efficiency of management of information flows.
B)By obtaining access to low cost sources of funds.
C)By linking services to the quality of the FI's technology.
D)By innovating new interest earning products.

Question 12

A major advantage of EFTPOS is that:

A)the transaction value will be debited from the customer's account at a later point in time
B)customers can use cheques to pay for their purchases
C)customers do not have to carry cash to make purchases
D)All of the listed options are correct.

Question 13

The term daylight overdraft refers to a situation in which an FI's:

A)reserve account at the central bank is negative at the end of a banking day
B)reserve account at the central bank is negative at the beginning of a banking day
C)reserve account at the central bank becomes negative within the banking day
D)account with another FI becomes negative within the banking day

Question 14

Operational risk came into prominence during the global financial crisis (GFC) due to:

A)Lehman Brothers using 'recycled collateral' to expand their funding beyond on-balance-sheet assets
B)the classification of 'sophisticated investors' led to investment banks not providing material information about the riskiness of derivative transactions
C)the credit default swap market was likely to cause systemic market risk due to difficulties in settling out trades with distressed or failed counterparties
D)All of the listed options are correct.

Question 15

The following information is available on the average costs of the three major banks in a given local market.Bank A has assets of $10 million and average costs are 15%, Bank B has assets of $20 million and average costs of 13% while Bank C has assets of $30 million with average costs of 12%.Average costs are measured as a proportion of total assets.The above figures indicate that:

A)there are significant economies of scale still present in the local markets
B)there are significant diseconomies of scale still present in the local markets
C)there are significant economies of scope still present in the local markets
D)there are significant diseconomies of scope still present in the local markets

Question 16

Diseconomies of scale refers to the:

A)fall in an FI's average costs of production as its output decreases
B)fall in an FI's average costs of production as its output increases
C)fall in an FI's average costs of production as its output remains stable
D)increase in an FI's average costs of production as its output increases

Question 17

Which of the following implies that small FI's are more cost efficient than large FI's, and that in a freely competitive environment for financial services, small FI's may outperform their larger counterparts?

A)economies of scale
B)diseconomies of scale
C)economies of scope
D)diseconomies of scope

Question 18

Which of the following statements is true?

A)The profitability of any product innovation is negatively related to the size of the stream of expected net cash flows from selling the services.
B)The profitability of any product innovation is positively related to the size of the stream of expected net cash flows from selling the services.
C)The profitability of any product innovation is unrelated to the size of the stream of expected net cash flows from selling the services.
D)The relationship depends on the FI's individual situation.

Question 19

Smart cards allow customers to:

A)spend money for various transactions, whereby the transaction value will be directly debited from the customer's account
B)store and spend money for various transactions using a card that has a chip-storage device
C)spend money for various transactions without having to pay the balance until a pre-set due date
D)access their funds overseas

Question 20

Potential reasons that technologically based product innovations result in a negative net present value are:

A)competitors' ability to mimic these products after long periods of time
B)uncertainties over revenues and costs of these projects
C)uncertainties over revenues and costs of these projects and competitors' ability to mimic these products after long periods of time
D)certainty of cash flows and competitors' ability to mimic these products quickly

Question 21

Which of the following scenarios is most desirable for the FI?

A)The initial set-up and development costs are lower than the sum of the discounted present values of cash flows from selling the product.
B)The initial set-up and development costs exceed the sum of the discounted present values of cash flows from selling the product.
C)The initial set-up and development costs equal the sum of the discounted present values of cash flows from selling the product.
D)The most desirable scenario depends on the FI's individual situation.

Question 22

To offset costs arising from operational risks, FI managers spend considerable efforts on the following:

A)loss prevention, loss control, loss financing and loss insulation
B)loss prevention, loss control, loss investment and loss insulation
C)loss provisioning, loss control, loss financing and loss insulation
D)loss prevention, loss control, loss financing and loss creation

Question 23

Assume that ABC Bank produces product A for a corporate client, while XYZ Bank produces product B for the client.The total operating cost for producing product A is $200 000 and $300 000 for product B.The resulting business volumes for the FI are $7 500 000 for product A and $10 000 000 for product B.What is the total average cost of producing products A and B separately (round to two decimals)?

A)5.67%
B)35%
C)70.84%
D)2.86%

Question 24

Which of the following statements is true?

A)Exchange settlement accounts allow each FI to have settlement for transactions that occur by the adjustment of credit balances held with the central bank.
B)The central bank acts purely as a settlement agent.
C)The central bank is not exposed to any credit risk.
D)All of the listed options are correct.

Question 25

The total operating cost of producing services is $125 000 for a loan volume of $12 500 000.What is the average cost of loan production for the bank?

A)0.1%
B)1%
C)10%
D)100%

Question 26

Which of the following statements is false?

A)Regulations can affect the profitability of technological innovations.
B)Regulations can hinder the rate and types of innovations.
C)Typical regulations include caps on loan rates such as usury ceilings.
D)Regulations are predominantly implemented to enhance FIs' profitability.

Question 27

Which of the following expressions describes economies of scope?

A)AC_A+B│X₁,X₂│ < AC_A│X₁,0│ + AC_B│X₂,0│
B)AC_A+B│X₁,X₂│ > AC_A│X₁,0│ + AC_B│X₂,0│
C)AC_A+B│X₁,X₁│ < AC_A│X₁,0│ + AC_B│X₁,0│
D)AC_A+B│X₁,X₂│ = AC_A│X₁,0│ + AC_B│X₂,0│

Question 28

Some benefits of technological advancement for FIs include:

A)convenience and service quality
B)lower operating cost, cross-marketing and cross-selling potential
C)less direct contact with customers
D)All of the listed options are correct.

Question 29

Operational risk sources can lead to the following costs for the FI:

A)direct costs, indirect costs and opportunity costs
B)direct costs and indirect costs only
C)direct costs and opportunity costs only
D)indirect costs and opportunity costs only

Question 30

Which of the following observations concerning the intermediation approach is true?

A)The intermediation approach views FIs' outputs of services as having two underlying inputs.
B)Labour and capital are the only inputs.
C)The intermediation approach views the output as being produced by labour, capital and the funds used to produce intermediated services.
D)Premiums or reserves are viewed as an input in the banking and thrift industries.

Question 31

Which of the following statements is true?

A)RTGS stands for Real Transaction Gross Settlement.
B)RTGS allows large transactions to be settled at the end of the banking day.
C)The use of RTGS eliminates settlement risk.
D)RTGS allows detecting any failure to complete settlement during the day that the transactions occur.

Question 32

Specific problems that can create capital asset risk include:

A)fire/flood
B)contractual disagreement
C)war
D)error

Question 33

Specific problems that can create employee risk include:

A)war; external fraud
B)management information
C)money laundering; rogue trading and fraud risk
D)taxation risk; confidentiality breach

Question 34

Assume that ABC Bank produces product A for a corporate client, while XYZ Bank produces product B for the client.The total operating cost for producing product A is $200 000 and $300 000 for product B.The resulting business volumes for the FI are $7 500 000 for product A and $10 000 000 for product B.Further assume that if the two banks merged they would be able to achieve $50 000 in cost efficiencies.What is the average cost of producing products A and B if the two institutions merged (round to two decimals)?

A)3.14%
B)5.08%
C)5.67%
D)2.57%

Question 35

The average cost of producing an FI's output of financial services is measured as follows:

A)AC = TC - S
B)AC = TC + S
C)AC = TC * S
D)AC = TC / S

Question 36

Which of the following statements is true?

A)Various studies have shown that economies of scale best explain cost discrepancies between FIs.
B)Various studies have shown that economies of scope best explain cost discrepancies between FIs.
C)Various studies have shown that X-inefficiencies best explain cost discrepancies between FIs.
D)Various studies have shown that Y-inefficiencies best explain cost discrepancies between FIs.

Question 37

Which of the following statements is false?

A)Large-scale investments may result in excess capacity problems.
B)Large-scale investments may result in integration problems.
C)Large-scale investments may result in problems of capacity constraints.
D)Large-scale investments may result in cost overruns.

Question 38

Which of the following statements is true?

A)Internet transactions involve 'open' systems and thus are well protected against interception and fraud.
B)Internet transactions involve 'closed' systems and thus are well protected against interception and fraud.
C)Internet transactions involve 'closed' systems and thus are susceptible to interception and fraud.
D)Internet transactions involve 'open' systems and thus are susceptible to interception and fraud.

Question 39

Which of the following statements is true?

A)FI's should invest in as much technology as possible as it will provide the FI with a competitive advantage.
B)FI's need to strike a balance as both, too much and too little investment in technology can be bad for the FI.
C)FI's should invest in as little technology as possible as these investments are too risky.
D)Technology investments do not have an impact on the survival and profitability of the FI.

Question 40

Which of the following statements is false?

A)The long-run implication of economies of scale on the FI sector is that the larger and most cost-efficient FIs will drive out smaller FIs.
B)A potential long-run implication of economies of scale on the FI sector is an increase in large-firm dominance.
C)A potential long-run implication of economies of scale on the FI sector is a concentration in financial services production.
D)A potential long-run implication of economies of scale on the FI sector is a decrease in large-firm dominance.

Question 41

Which of the following is not a source of operational risk for an FI?

A)capital assets
B)customer relationships
C)technology
D)positive duration gap

Question 42

Daylight overdrafts occur when:

A)FIs in different time zones clear transactions
B)FI debits exceed credits during the day
C)FI credits exceed debits during the day
D)the sum of all debits transmitted over the system exceeds the sum of all credits during the day

Question 43

Which of the following is consistent with economies of scope? The subscript 'b' refers to a banking firm, 's' for a securities firm, 'AC' is average costs and 'TC' is total costs.

A)AC_b+s > AC_b + AC_s
B)AC_b+s = AC_b + AC_s
C)AC_b+s < AC_b + AC_s
D)TC_b+s < TC_b + TC_s

Question 44

External fraud (as sources of operational risk) is internally controllable by FI management.

Question 45

Customer relationships (as sources of operational risk) are internally controllable by FI management.

Question 46

Diseconomies of scale refers to the increase in an FI's average costs of production as its output increases.

Question 47

Which of the following observations concerning the production approach is true?

A)It views FIs' outputs of services as having three underlying inputs.
B)Labour and capital are the only inputs.
C)It views the output as being produced by labour, capital and the funds used to produce intermediated services.
D)Deposit costs are viewed as an input in the banking and non-banking deposit institutions.

Question 48

According to studies, which of the following may better explain cost differences and operating cost efficiencies among FIs?

A)diseconomies of scale
B)economies of scale
C)economies of scope
D)X-inefficiencies

Question 49

The term economies of scope refers to the ability of an FI to generate synergistic cost savings through joint use of inputs in producing multiple outputs.

Question 50

The term diseconomies of scope refers to the situation in which the costs of joint production of FI services are higher than they would be if they were produced independently.

Question 51

Which of the following are potential benefits of technology for an FI?

A)service quality, especially for customers of large banks
B)the rate of innovation of new products has increased
C)FIs can more easily cross-market new and existing products to customers
D)All of the listed options are correct.

Question 52

Which of the following are the two basic approaches to analysing the cost functions of FIs?

A)basic indicator approach and standardised approach
B)standardised approach and advanced measurement approach
C)production approach and intermediation approach
D)basic indicator approach and advanced measurement approach

Question 53

How can the operating income of an FI be increased by improved technological efficiency?

A)By improving the efficiency of management of information flows.
B)By obtaining access to low cost sources of funds.
C)By linking services to the quality of the FI's technology.
D)By innovating new interest-earning products.

Question 54

Retail customers mostly prefer to obtain their cash by withdrawing it from an ATM.Since 2005:

A)there has been a general upward trend in the growth of ATM use
B)growth in ATM use has been static
C)there has been a general downward trend in the growth of ATM use
D)None of the listed options are correct.

Question 55

Economies of scale refers fall in an FI's average costs of production as its output increases.

Question 56

Which of the following statements is true?

A)Operational risk is not considered to be important in FI's and thus regulatory authorities assume that it is captured by an FI's general risk management framework.
B)Operational risk is considered to be important and thus the Basel Committee requires FI's to provision against their operational risk exposures.
C)Operational risk is considered to be important and thus the Basel Committee requires FI's to allocate capital against their operational risk exposures.
D)Operational risk is considered to be important; however, regulators are aware that FI's have well-functioning operational risk defence mechanisms in place.

Question 57

How can the interest income of an FI be increased by improved technological efficiency?

A)By improving the efficiency of management of information flows.
B)By obtaining access to low cost sources of funds.
C)By linking services to the quality of the FI's technology.
D)By innovating new interest-earning products.

Question 58

How can the interest expense of an FI be reduced by improved technological efficiency?

A)By improving the efficiency of management of information flows.
B)By obtaining access to low cost sources of funds.
C)By linking services to the quality of the FI's technology.
D)By innovating new interest-earning products.

Question 59

Which of the following occurs if the costs of joint production of FI services are higher than they would be if they were produced independently?

A)economies of scale
B)diseconomies of scale
C)economies of scope
D)diseconomies of scope

Question 60

Technological efficiency focuses exclusively on the cost side of financial intermediation.

Question 61

The term daylight overdraft refers to a situation in which an FI's reserve account at the central bank becomes negative within the banking day.

Question 62

Regulators have proposed that operational risk should be measured for the purpose of meeting overall capital adequacy.

Question 63

What are the advantages and disadvantages of technological advancements from the viewpoint of FIs? Use examples where appropriate.

Question 64

The effect of improving technology over time is to shift the AC curve upwards over time.

Question 65

The term daylight overdraft refers to a situation in which an FI's reserve account at the central bank is negative at the end of a banking day.

Question 66

External insurance is one way of operational risk loss prevention.

Question 67

To provide retail financial services, FIs need continuously update and integrate their technology infrastructure.Discuss
the specific technological advances FIs must deal with.

Question 68

Distinguish between diseconomies of scale and diseconomies of scope.How could they occur?

Question 69

There is little strong evidence that larger multi-product financial service firms enjoy cost advantages over smaller, more specialised firms.

Question 70

Cost inefficiencies related to managerial performance and other hard-to-quantify factors are also called X-inefficiencies.

Question 71

The success in technologically related innovation often is dependent on changes in regulations and regulatory procedures.

Question 72

External and internal fraud are both sources of operational risk.

Question 73

Outline the main sources of operational risk and why operational risk gained prominence during the GFC.

Question 74

According to KPMG there has been a decline in the number of credit cards on issue, while there was no slowdown in transaction activity.

Question 75

According to economic theory involving economies of scale, larger and more cost-efficient FIs should prevail over smaller, less cost-efficient FIs.

Question 76

Losses on technological innovations and new technology could weaken an FI because scarce capital resources were invested in value-decreasing projects.

Question 77

Inputs such as capital and labour cannot be jointly used by FIs.