Banking Risk Management 3 — Questions and Answers
Question 1: What is the primary purpose of a bank's stress testing program?
- To maximize loan portfolio yield
- To evaluate capital adequacy under adverse economic scenarios (Correct answer)
- To set employee performance targets
- To determine dividend payout ratios
Correct answer: To evaluate capital adequacy under adverse economic scenarios
Stress testing assesses whether a bank maintains sufficient capital to absorb losses during hypothetical adverse economic conditions.
Question 2: Which of the following best describes 'operational risk' in a banking context?
- Risk from adverse interest rate movements
- Risk of loss from inadequate processes, people, systems, or external events (Correct answer)
- Risk from borrower default
- Risk from currency exchange fluctuations
Correct answer: Risk of loss from inadequate processes, people, systems, or external events
Operational risk covers losses stemming from internal failures—people, processes, systems—or external events like fraud or natural disasters.
Question 3: Under the Net Stable Funding Ratio (NSFR), which of the following is the correct relationship that must be maintained?
- Available Stable Funding ≥ Required Stable Funding (Correct answer)
- Required Stable Funding ≥ Available Stable Funding
- Liquid Assets ≥ Short-term Liabilities
- Total Deposits ≥ Total Loans
Correct answer: Available Stable Funding ≥ Required Stable Funding
The NSFR requires that Available Stable Funding (ASF) must equal or exceed Required Stable Funding (RSF) to ensure long-term liquidity resilience.
Question 4: A bank's risk appetite statement is best described as:
- A list of all potential risks in the institution
- The amount and type of risk the bank is willing to accept to achieve its objectives (Correct answer)
- Regulatory capital requirements set by the Fed
- The bank's historical loss experience over five years
Correct answer: The amount and type of risk the bank is willing to accept to achieve its objectives
A risk appetite statement defines the level and types of risk the board and management are willing to accept in pursuit of strategic goals.
Question 5: Which of the following scenarios represents 'basis risk' in banking?
- A borrower defaults on a mortgage loan
- A bank's LIBOR-based loans are funded by Prime-rate deposits, and the two rates move differently (Correct answer)
- A cyberattack disrupts online banking services
- A bank holds too many illiquid assets
Correct answer: A bank's LIBOR-based loans are funded by Prime-rate deposits, and the two rates move differently
Basis risk occurs when two related interest rates or indices do not move in perfect correlation, creating unexpected gains or losses.
Question 6: The three lines of defense model in banking risk management assigns which role to internal audit?
- First line — owning and managing risk daily
- Second line — risk oversight and policy setting
- Third line — independent assurance and testing (Correct answer)
- Fourth line — regulatory examination
Correct answer: Third line — independent assurance and testing
Internal audit serves as the third line of defense, providing independent assurance that risk controls and governance processes are effective.
Question 7: A bank sells credit default swaps (CDS) to transfer credit risk off its balance sheet. Which risk does the bank retain regarding the CDS counterparty?
- Regulatory risk
- Counterparty credit risk (Correct answer)
- Prepayment risk
- Sovereign risk
Correct answer: Counterparty credit risk
Even after transferring credit risk via CDS, the bank faces counterparty credit risk—the risk the CDS seller fails to pay when a credit event occurs.
Banking Risk Management 3
What is the primary purpose of a bank's stress testing program?