Banking Exam Credit Risk and Analysis 2 — Questions and Answers
Question 1: Which ratio best measures a borrower's ability to service debt from operating cash flow?
- Debt-to-equity ratio
- Debt service coverage ratio (DSCR) (Correct answer)
- Current ratio
- Quick ratio
Correct answer: Debt service coverage ratio (DSCR)
DSCR equals net operating income divided by total debt service, directly measuring cash flow adequacy for loan repayment.
Question 2: A borrower's credit score drops from 720 to 640 during underwriting due to a new delinquency. What is the most appropriate lender action?
- Proceed with original loan terms
- Re-underwrite the loan under updated risk parameters (Correct answer)
- Automatically deny the application
- Ignore the change since the application was already filed
Correct answer: Re-underwrite the loan under updated risk parameters
Material changes in credit profile require re-underwriting to ensure the loan still meets risk standards.
Question 3: In credit analysis, 'concentration risk' refers to:
- High interest rate exposure on a single loan
- Overexposure to a single borrower, sector, or geography (Correct answer)
- The risk that a borrower concentrates spending in one area
- Regulatory limits on loan size
Correct answer: Overexposure to a single borrower, sector, or geography
Concentration risk arises when a portfolio is heavily exposed to a single borrower, industry, or region, amplifying potential losses.
Question 4: Which Basel framework introduced the requirement for banks to hold capital against operational risk in addition to credit and market risk?
- Basel I
- Basel II (Correct answer)
- Basel III
- Dodd-Frank Act
Correct answer: Basel II
Basel II expanded the capital framework to include operational risk as a third pillar alongside credit and market risk.
Question 5: A 'covenant-lite' loan is characterized by:
- Lower interest rates than standard loans
- Fewer or no maintenance financial covenants protecting the lender (Correct answer)
- Additional collateral requirements
- Shorter maturity terms
Correct answer: Fewer or no maintenance financial covenants protecting the lender
Covenant-lite loans lack traditional maintenance covenants, reducing the lender's early warning signals and protective triggers.
Question 6: What does a 'vintage analysis' in credit risk assess?
- The age of collateral securing a loan
- Loan performance grouped by origination period to identify underwriting quality trends (Correct answer)
- Historical interest rate trends by decade
- The creditworthiness of wine-industry borrowers
Correct answer: Loan performance grouped by origination period to identify underwriting quality trends
Vintage analysis tracks default and delinquency rates by origination cohort, revealing how economic conditions and underwriting standards affect performance.
Question 7: Which of the following best describes 'expected loss' (EL) in credit risk modeling?
- The maximum possible loss on a portfolio
- The product of probability of default, loss given default, and exposure at default (Correct answer)
- The loss after all recovery efforts are exhausted
- Regulatory minimum capital requirement
Correct answer: The product of probability of default, loss given default, and exposure at default
EL = PD × LGD × EAD, representing the average loss a bank anticipates from a credit exposure over a given period.
Banking Exam Credit Risk and Analysis 2
Which ratio best measures a borrower's ability to service debt from operating cash flow?