Chapter 9 - Problem Solving

Question 1

What is the primary objective of the asset-liability management (ALM) function in a bank?

Answer 1

To ensure adequate and robust liabilities to support the assets being originated.

Question 2

What major change occurred to Northern Rock in 1997?

Answer 2

It changed from a mutual savings-and-loan organisation to a bank.

Question 3

What was the main product focus of Northern Rock?

Answer 3

Residential mortgages.

Question 4

True or False: Northern Rock’s retail deposit base expanded significantly after its transformation into a bank.

Answer 4

False.

Question 5

What led to the high-street bank run on Northern Rock in September 2007?

Answer 5

The inability to roll its overnight funding and subsequent media headlines.

Question 6

What should banks aim to match to avoid liquidity risks?

Answer 6

Maturity between assets and liabilities.

Question 7

List three lessons learned from the Northern Rock case.

Answer 7

• Monitor liquidity ratios
• Arrange diversified funding
• Grow at a measured and sustainable pace

Question 8

What issue was identified during the ILAA review of a UK bank in 2010?

Answer 8

The public funding curve was misaligned with market prices.

Question 9

What was the risk management issue related to the internal yield curve construction process?

Answer 9

No recognised best-practice interpolation method was employed.

Question 10

What was a significant risk-management decision related to the internal yield curve?

Answer 10

Selecting the internal yield curve construction methodology.

Question 11

Fill in the blank: A bank’s internal yield curve is crucial for _______.

Answer 11

[pricing and risk management process].

Question 12

What assumption was challenged regarding the FTP methodology at Europe Arab Bank?

Answer 12

That the bank could fund across the term structure at zero spread over Libor.

Question 13

During the global financial crash, what was the loan-deposit ratio (LDR) for corporate banking at EAB?

Answer 13

Approximately 180%.

Question 14

What did treasury at EAB implement to improve its FTP process?

Answer 14

A liquidity-premium-enhanced FTP.

Question 15

What was the initial FTP regime used at EAB?

Answer 15

All internal funds were transacted at Libor-flat.

Question 16

What was one of the main objectives of the new FTP regime implemented at EAB?

Answer 16

To incentivise corporate banking to attract more customer deposits.

Question 17

What action did treasury take to address objections from business lines regarding the new FTP regime?

Answer 17

Assured that flagged internal deal tickets would not count towards treasury P&L.

Question 18

True or False: The FTP changes at EAB were implemented without regulatory review.

Answer 18

False.

Question 19

What is a key factor in the liquidity premium introduced in the new FTP?

Answer 19

It increases as a function of the tenor.

Question 20

What is the definition of liquidity premium?

Answer 20

Liquidity premium is the additional return expected by investors for holding less liquid assets.

Question 21

What does O/N to 2 weeks > LIBOR - 12.5 bps indicate?

Answer 21

It indicates a borrowing rate that is 12.5 basis points lower than LIBOR for overnight to 2-week maturities.

Question 22

What is the LIBOR rate for 2 weeks to 1 month?

Answer 22

LIBOR - 12.5 bps.

Question 23

What is the LIBOR rate for 1 to 3 months?

Answer 23

LIBOR + 10 bps.

Question 24

What does LIBOR + 32.5 bps signify for 3 to 12 months?

Answer 24

It signifies a borrowing cost that is 32.5 basis points higher than LIBOR for maturities between 3 and 12 months.

Question 25

What was the base rate for EAB deposit rates in June 2009?

Answer 25

50 basis points.

Question 26

What rate was offered for a 1-year deposit at EAB in June 2009?

Answer 26

100 basis points.

Question 27

What was the impact on corporate banking due to the need for liquidity-friendly customer term deposits?

Answer 27

Stopped writing back-stop liquidity facilities and term loans became less competitive.

Question 28

What is the crucial operational issue regarding the treasury in the context of P&L?

Answer 28

Demonstrating that treasury did not generate and report P&L based on the FTP regime.

Question 29

What is the purpose of the ALCO Book?

Answer 29

To hold the P&L of FTP tickets centrally.

Question 30

What is the significance of the treasury updating the curve monthly?

Answer 30

It ensures that term liquidity premium rates are calculated using market-observed external parameters.

Question 31

What is the objective of the treasury desk in any bank?

Answer 31

To undertake prudent management of the funding requirement regarding liquidity management, interest-rate management, and funding diversification.

Question 32

Fill in the blank: The primary deliverable of the treasury desk is the _______.

Answer 32

ALM report.

Question 33

What should the funding function report to ensure management attention?

Answer 33

A person of sufficient seniority.

Question 34

What is the maximum percentage limit for any one maturity bucket of total funding requirement?

Answer 34

20%.

Question 35

True or False: The CBD treasury department was able to effect rationalization to the governance structure easily.

Answer 35

False.

Question 36

What happened to the lower-tier ALCOs in the European universal banking institution case study?

Answer 36

They were abolished in favor of a single, unified CBD ALCO.

Question 37

What was the total balance sheet size of the CBD in the case study?

Answer 37

Over GBP 180 billion.

Question 38

Fill in the blank: The ALCO process at the corporate banking division was deemed not fit-for-purpose due to _______.

Answer 38

Inefficiency and risk of exposures falling through the cracks.

Question 39

What is a key lesson learned regarding management strategy and revenue?

Answer 39

Do not allow management strategy to be overwhelmed by the revenue side of the balance sheet.

Question 40

What was the primary motivation for the firm’s historical funding concentration?

Answer 40

The short-term trading nature of its assets.

Question 41

What should be highlighted to ensure management action on issues?

Answer 41

What the regulatory authorities would say if they were aware of relevant facts.

Question 42

What is the significance of management reporting in the treasury function?

Answer 42

To ensure transparency regarding funding usage and risk management.

Question 43

What was the redesign of the ALCO pack aimed at?

Answer 43

To be more user-friendly, accessible, and succinct.

Question 44

What is a key lesson learned regarding risk governance?

Answer 44

To continuously review risk governance and operating model to ensure it is still optimum.

Question 45

What is gap risk in the context of IRRBB?

Answer 45

The risk that revenue and earnings decline as a result of changes in interest rates due to the difference in the maturity profile of assets, liabilities, and off-balance-sheet instruments.

Question 46

Define yield curve risk

Answer 46

The risk that non-parallel or pivotal shifts in the yield curve cause a reduction in net interest income (NII).

Question 47

What is basis risk?

Answer 47

Arising because assets are often priced off one interest rate, while funding is priced off another interest rate.

Question 48

What does run-off risk refer to?

Answer 48

Associated with the non-interest-bearing liabilities of banks and the opportunity cost to depositors.

Question 49

What is option risk in banking?

Answer 49

When banking products entitle the customer to terminate contractual arrangements ahead of the stated maturity.

Question 50

What are the primary sources of IRRBB?

Answer 50

* Writing fixed-rate assets funded by floating-rate liabilities * Writing floating-rate assets funded by floating-rate liabilities referencing another index.

Question 51

How is IRRBB hedging typically undertaken?

Answer 51

On a 'macro' or aggregate balance sheet basis.

Question 52

What is the orthodox approach to IRRBB hedging?

Answer 52

Hedging asset-side IRRBB as it appeared and liabilities-side IRRBB as they appeared, without considering the balance sheet as an integrated whole.

Question 53

What is the main hedging tool used by banks for interest rate risk?

Answer 53

Interest rate swaps.

Question 54

What is a recommended approach for hedging IRR exposure?

Answer 54

To use cash products to hedge IRR exposure rather than derivatives.

Question 55

What lessons were learned from the case of Capital One's cyberattack?

Answer 55

* Need for more regulation and compliance * Importance of better governance processes and early-warning systems.

Question 56

What are the four themes of cyberattacks?

Answer 56

* Internal malicious * Internal unintentional * External malicious * External unintentional.

Question 57

What was the outcome of the Capital One cyberattack in terms of penalties?

Answer 57

Capital One was ordered to pay a US$80 million civil penalty.

Question 58

What is a defining characteristic of blockchain technology?

Answer 58

* Decentralised * Democratised * Secure * Transparent * Trustless * Time-stamped and programmable.

Question 59

What was the first financial institution to execute a live global trade transaction using blockchain?

Answer 59

Barclays Africa (now Absa Group).

Question 60

What are the benefits of using blockchain technology in banking?

Answer 60

* Cost savings * Reduced risk of document forgery * Increased security * Reduced operational risk * Enhanced data collection.

Question 61

What are some disadvantages of implementing blockchain in banking?

Answer 61

* Scalability issues * High implementation costs * Regulatory challenges * Increased complexity.

Question 62

Fill in the blank: Cyber risk is commonly defined as exposure to harm or loss resulting from breaches of, or attacks on _______.

Answer 62

[information systems]

Question 63

True or False: The use of derivatives in hedging IRRBB is always efficient and optimum.

Answer 63

False

Question 64

What is the potential impact of remote working on cybersecurity?

Answer 64

It may affect cybersecurity in various ways.

Question 65

What is the true cost of applying blockchain within the banking environment?

Answer 65

The true cost of applying blockchain includes implementation expenses, training costs, and potential disruption to existing systems. ## Footnote Costs may vary significantly based on the size of the bank and the complexity of the blockchain solution.

Question 66

Is there a need for further regulations on utilizing blockchain in banking?

Answer 66

Yes, further regulations may be necessary to address legal, compliance, and operational challenges associated with blockchain technology. ## Footnote Existing regulations may not fully cover the unique aspects of blockchain, such as smart contracts and data privacy.

Question 67

How can increased cyber risks associated with blockchain be mitigated?

Answer 67

Increased cyber risks can be mitigated through enhanced security protocols, regular audits, and by employing advanced encryption techniques. ## Footnote Organizations should also invest in cybersecurity training for employees to recognize potential threats.

Question 68

Are there unforeseen operational risks with utilizing blockchain technology?

Answer 68

Yes, unforeseen operational risks may include integration challenges with legacy systems and potential transaction delays. ## Footnote These risks can affect the overall efficiency and reliability of banking operations.