Others

Question 1

What is ‘expected shortfall’?

Answer 1

The average loss, for a given time and confidence level, that could occur in excess of the loss calculated by VaR. Expected shortfall will always be greater than VaR because it is estimating loss in the extreme tail in the distribution beyond the VaR loss value. It is more difficult and inaccurate to predict than VaR.

Question 2

What are the main similarities between Solvency 2 and Basel II/III?

Answer 2

1. Both have a three pillar approach
2. Both have similar aims:
   
   1. Create incentives for firms to better understand and manage risks
   2. Create a prudential framework more appropriate to the true risks facing firms
3. Both move away from a ‘one size fits all’ approach (e.g. fixed %)
4. Both have several ways of calculating capital
5. Both have increased focus on calculating operational risks

Question 3

What are the main differences between Solvency 2 and Basel II/III?

Answer 3

1. Basel II/III is international, wheras Solvency 2 is EU
2. Risk is the main business for insurers
3. Insurers also have actuarial risks
4. Insurers in some jursitictions (e.g. UK) already have an internal capital process so the changes between Solvency 1-2 are less radical than for banks in Basel I-II

Question 4

What does the ‘balance sheet’ have on it?

Answer 4

1. Assets
2. Liabilities
3. Equity

Question 5

What is a capital ratio?

Answer 5

The relationship between risk weighted assets and regulatory capital

Question 6

What is the liquidity coverage ratio?

Answer 6

One of two new liquidity standards introduced in Basel III

Banks should hold enough High Quality Liguidity Assets (HQLA) to be able to withstand (by selling or pledging those assets) the net outflow of liquidity arising from financial stress lasting 30 days

Question 7

What is macro prudential supervision?

Answer 7

Supervision that focusses on the stability of the financial system as a whole, rather than components.

Individual banks could be working within the regulations, however collectivley thier actions could lead to instability.

Question 8

What is micro pridential supervision?

Answer 8

Firm-level oversight or financial regulation by regulators of financial institutions, “ensuring the balance sheets of individual institutions are robust to shock

Question 9

What is non-systemic risk?

Answer 9

Risk resitricted to a limited number of entities

Question 10

What is a regulatory capital requirement?

Answer 10

Specifies how much minimum capital a bank must hold to guard against the various risks (e.g. market, credit and operational risks)

Question 11

What are risk weighted assets?

Answer 11

Risk weighted assets equal the sum of various financial assets multiplied by their respective risk weights, and off balance sheet items waited for their credit risk according to the regulatory requirements

Question 12

What is securitisation?

Answer 12

Securitization is a process where relatively illiquid cash flow producing assets such as mortgages credit cards or loans are grouped into a portfolio and the purchase of these assets in the portfolio is financed by securities issued to investors, who then share the cash flows generated by the portfolio.

Question 13

What is tier 1 capital?

Answer 13

In the Basel accords it is the core capital of the bank and refers to equity capital and to certain types of disclosed reserves, as well as particular debt or equity hybrid securities

Question 14

What is tier 2 capital?

Answer 14

In the Basel records it is supplementary capital and refers to undisclosed and certain disclosed reserves, general provisions, general loss reserves, hybrid capital instruments, and subordinated debt.

Question 15

What is tier 3 capital?

Answer 15

In courts it is a specific type of supplementary capital and refers to certain types of short term debt that can partially satisfy regulatory minimum capital requirements for market risk only

Question 16

What are the 3 main functions of a bank?

Answer 16

1. Deposit collection
2. Payment arrangement
3. Loan underwriting

Question 17

What are the main functions that a bank has in the context of the banking system?

Answer 17

1. Financial intermediation (transferring money from deposits to borrowers)
2. Asset transformation (creating loans from deposits)
3. Money creation

Question 18

What is fractional reserve banking?

Answer 18

Keeping only a small fraction of the depositors reserves available for withdrawl

Question 19

What is a retail bank?

Answer 19

Serves individuals (‘consumers’), and maybe SMEs

Question 20

What are the 3 main types of retail banks?

Answer 20

1. Retail banks (and cooperatives)
2. Private banks (wealth management, tax and investment advice)
3. Postal banks (post offices)

Question 21

What is a wholesale bank?

Answer 21

Serve corporate businesses

Question 22

What are the 3 main types of wholesale bank?

Answer 22

1. Commercial banks (specialised loans for large firms, fund raising intermediaries)
2. Correspondant banks (banking services to other banks)
3. Investment banks (aka merchant banks) serve firms through capital markets (stocks, bonds, and credit)