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IC101-Chapters 1-7 > Chapter 7 > Flashcards

Chapter 7 Flashcards

1
Q

Why are banks special?

A

A high proportion of their liabilities have a fixed value

Their liabilities comprise a high proportion of the money supply of a country

They are involved in running major payment systems in a country

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2
Q

How do bank raise funds?

A

Deposits

Issuing bonds

Short-term securities

Equity shares

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3
Q

Banks lend to who?

A

Household firms

Governments

Other banks

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4
Q

Credit risk transformation by banks is partly a result of what?

A

Creating liabilities which use priority of claims

Diversification of assets

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5
Q

Maturity transformation results from what ?

A

A willingness by a bank to increase the liquidity of its customers by creating an illiquid balance sheet for itself

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6
Q

On what basis do banks price loans ?

A

Probability of the loan defaulting and their probable loss given default

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7
Q

What are expected losses met from?

A

Revenues

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8
Q

Banks are unable to lend profitably to AAA companies because of what?

A

AAA companies can borrow at a lower rate than most banks

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9
Q

What can banks provide credit for?

A

The expansion of real investment

High value asset transfer

To enable some households to consume more than their after-tax income b

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10
Q

Dis-intermédiation in finance is a result of what?

A

A reduced need for intermediaries in finance and a reduced ability to intermediate profitably

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11
Q

What are the key types of intermediaries in any economy?

A

Central banks

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12
Q

Most commercial banks have what banking operation?

A

A retail and a wholesale

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13
Q

What does the whole sale banking operation do?

A

Involved in large scale lending including cross border lending

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14
Q

Are mutual fund holdings fixed or variable value assets ?

A

Variable

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15
Q

What type of funds do not benefit from deposit insurance ?

A

Mutual funds

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16
Q

What is an insurance fund?

A

Scheme by government or private sector which pays back deposits to customers in case bank fails

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17
Q

What are the features of banks that make them special in any economy?

A

Fixed nominal values

Instant redeemability

Money supply

Essential credit

Payments system

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18
Q

A sharp fall in credit provision could lead to What?

A

Lack of credit availability to lubricate the wheels of the economy

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19
Q

What is the purpose of regulation ?

A

To minimise the likelihood of collapse and hence the need for tax payer support

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20
Q

What does the liability side of the balance sheet involve?

A

Issuing liabilities for investors, savers and other banks to hold to finance banking

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21
Q

What does the asset side of the balance sheet do?

A

Creates household and business liabilities to provide financin*

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22
Q

How are consumer loans, mortgages and corporate loans securitised ?

A

They are taken off the bank balance sheet and sold to other financial institutions

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23
Q

What is size transformation?

A

Pooling services

24
Q

The fixed value liabilities that banks offer are usually what?

A

Nominally riskless assets

25
Q

What is credit transformation?

A

Lowering the risk of risky loans being offered

26
Q

How is credit transformation achieved ?

A

Portfolio diversification

Creating liabilities on balance sheet which use priority of claims

27
Q

What is idiosyncratic risk?

A

The risk that one large borrower creates a large percentage loss on the portfolio

28
Q

What type of risk is reduced by portfolio diversification ?

A

Idiosyncratic

29
Q

Between senior, junior debts and deposits, what takes the first loss?

A

Junior then senior then deposits

30
Q

Modigliani and Miller’s capital structure irrelevance theorem suggests what?

A

Average cost of financing the asset book of the bank cannot be lowered if there is no tax deductibility of interest and no costs involved in bankruptcy

31
Q

How can maturity transformation be achieved?

A

Through the banks ability to offer long term loans despite short term deposits

32
Q

How is credit intermediation achieved?

A

By borrowing at short maturity and providing risky loans at long term maturity

33
Q

Banks take one which type of risks?

A

Credit risk

Interest rate risk

Rollover risk or liquidity risk

34
Q

What is interest rate risk?

A

Cost of liabilities above the yield

35
Q

The two main type of risks banks are subject to are?

A

Solvency risk

Liquidity risk

36
Q

What are the two mechanisms available to banks to control risks?

A

A viable business model

A social contract with society

37
Q

What does viable business model include:

A

Pooling of funds

Skill in assessing risk of loans

Independent risks

Subordination

38
Q

What does a social contract with society include:

A

Stand by liquidity

Deposit insurance

Bank examiners

Market discipline

39
Q

What are the social contract and viable business model designed to do?

A

Minimise the risk of insolvency or illiquidity

40
Q

What is the too big to fail doctrine?

A

If financial institution is large, it cannot be allowed to fail impact on economic stability is too great

41
Q

What is the loan agreement?

A

Contract between borrower and lending bank

42
Q

What is the Great Moderation?

A

A period of low volatility in markets a low loan losses in the banking world

43
Q

On what two things do banks make an estimate of expected loss of loans?

A

Probability of default

Loss given default

44
Q

What is expected loss?

A

Percentage of assets of this type that it expects to lose in the year ahead as a cost of doing business

45
Q

Who is unexpected loss taken by?

A

Shareholder funds

46
Q

What does more equity capital at bank mean for the bank?

A

More protection for other capital providers

47
Q

Order of losses if bank has a loss greater than shareholder funds

A 
Shareholders 
preferred share holders 
subordinate debt holders 
mezzanine debt holders 
senior debt holders 
depositors
48
Q

How does a bank generate a higher return than targeted?

A

By having fewer write off charges

49
Q

What basis are loans priced on in the fixed income markets?

A

A spread above the treasury yield for a government bond

50
Q

What is floating rate?

A

The rate of interest changes every 1, 3, 6 or 12 months

51
Q

What are investment grade loans?

A

Loans made to high grade corporations which have relatively high credit rating

52
Q

What is the average bank rated as?

A

AA

53
Q

Why are AAA banks not willing to pay the AA rate?

A

They can go straight to the capital market without and intermediary

54
Q

What are leveraged loans?

A

Loans to companies with relatively low credit rating as result of high debt to equity ratio.

55
Q

What is a syndicated loan?

A

One which the funds supplied to the borrower come from a group of lenders rather than simply one bank

IC101-Chapters 1-7 (7 decks)

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