N1577 PRINCIPLES OF BANKING

Candidates must attempt ALL questions.

QUESTION 1

Consider the following summarised balance sheet and associated average interest rates for RBK bank over a one-year time frame:

a) Explain interest rate risk and how it arises from a bank’s perspective with specific reference to the 2007-09 financial crisis.

[4 marks]

b) Present the basic steps in static GAP analysis. What is the objective of each step?

[5 marks]

c) Calculate RBK bank’s (i) GAP, (ii) expected net interest income, and (iii) net interest margin if interest rates and portfolio composition remain constant during the year.

[6 marks]

d) Calculate the change in expected net interest income and net interest margin if the entire yield curve shifts 2 percent higher during the year. Comment on your answer and its implications for RBK bank’s GAP. Is this outcome consistent with RBK bank’s static GAP?

[10 marks]

Word limit: 800.

QUESTION 2

a) Consider the financial ratios of ABK Bank and the average ratios of peer banks based on 2015 year-end data shown in the table below:

Note that TAX = applicable income tax/total assets

Compare and critically discuss the performance of ABK Bank and that of its peer banks. Conduct a return on equity decomposition analysis for ABK bank and the peer banks as part of your discussion. What are the possible limitations in your analysis?

[15 marks]

a) Critically discuss the CAMELS ratings and its effectiveness in banking regulation.

[10 marks]

Word limit: 800.

QUESTION 3 (max word limit: 800 / Total marks: 25)

a) Explain the lender of last resort (LOLR) function of central banks. Provide some examples of the implementation of the LOLR function. Discuss the controversy surrounding the LOLR function.

[15 marks]

b) Might the elimination of central banks’ independence lead to a more pronounced political business cycle? Discuss.

[10 marks]

Word limit: 800.

QUESTION 4

a) Discuss the advantages and disadvantages of regulatory forbearance in banking. How useful has it been in mitigating COVID-19 stress on banks? Give some examples.

[10 marks]

b) Suppose that your bank is considering investing in a one-year project. The investment will cost $10 million and has an 80% chance of generating $19 million income, a 10% chance of generating $13 million income, a 7% chance of generating $8 million income and a 3% chance of generating nothing.

i) Illustrate the cumulative probability distribution for this project’s gains and losses [Feel free to draw the distribution by hand and paste a picture of it].

[4 marks]

ii) What is the one-year VaR for the project when the confidence level is 95%. What does it mean?

[4 marks]

iii) What is the Expected Shortfall (ES) when the confidence level is 95%?

[4 marks]

iv) What information does the Expected Shortfall measure provide which the VaR does not?

[3 marks]