CBM Question Bank

COMMERCIAL BANKING/BANK MANAGEMENT QUESTION BANK

Answers to Question No. 1 to 10 may be given in 50 to 100 words. Each question from No. 1 to 10 carries 2 marks.

Q 1. How would economic transactions between suppliers of funds and ultimate users of funds occur in a world without FIs ? Explain with the help of a diagram.

Q 2. Give three major reasons that suppliers of funds would not like to directly purchase securities issued by ultimate users of funds ?

Q 3. Explain, with the help of a diagram, the financial intermediation process/role performed by an FI ?

Q 4. What are the various kinds of financial intermediation roles performed by an FI ?

Q 5. How can an FI reduce/overcome those problems faced by primary savers/suppliers of funds in direct transfer of funds to ultimate users of funds ? (4 marks)

Q 6. What is meant by Maturity intermediation ?

Q 7. What is meant by Denomination intermediation ?

Q 8. What are the core/primary activities of a Commercial Bank ?

Q 9. What are the differences between the Balance Sheets of a Depository Institution like a Commercial Bank and a Non-financial Firm like a Manufacturing Company ?

Q 10. It is said that Commercial Banks are highly leveraged entities. Comment.

Q 11. Mention the different items that appear in a Bank’s Balance Sheet in India.

Q 12. Q 11. Mention the different items that appear in a Bank’s Income Statement (Profit & Loss Account) in India.

Q 13. Classify the following accounts into one of the following categories : (a) assets (b) liabilities (c) equity (d) revenue (e) expense (f) Off-Balance Sheet (OBS) activity.

(1) Retail Deposits (2) Paid-up-capital (3) Loan Commitments (4) Consumer loans (5) Interest on Investment securities (6) Interest on Savings Bank Deposits (7) Current Deposits (8) Letter of Credit (9) Retained earnings (10) Provision on NPA Loans

Q 14. Define Net Interest Income (NII) and Net Interest Margin (NIM).

Q 15. Define Operating Profit and Net Profit/Net Income in a Bank’s Income Statement.

Q 16. It is said that Bank’s Profitability Management boils down to two components : Spread Management ( or Management of NIM) and Burden or Overhead Management. Comment on the statement by explaining terms like Spread, NIM and Burden and the strategies to improve profitability of a Bank.

Q 17. It’s often said that Banks must rely less on Net Interest Income/ Core Income and more on the Non-Interest Income/Other Income. Comment on the statement defining the terms like Core Income and explaining (a) the various sources of Non-interest Income and (b) the sources and strategies to control the Non-interest expenses.

Q 18. What is meant by an Off-Balance Sheet (OBS) activity ? What are some of the forces responsible for them ?

Q 19. How does one distinguish between an off-balance sheet asset and an off-balance sheet liability ?

Q 20. What are the main off-balance sheet activities undertaken by commercial banks ?

Q 21. Banks typically differentiate between interest and non-interest income and expense. What are the primary components of each ? Define Net Interest Income (NIM) and burden. What does a bank’s efficiency ratio measure ?

Q 22. A bank’s efficiency ratio (ER) is defined as the ratio of Non-interest expense to the total of Net interest income and Non-interest income. Should the efficiency ratio be low or high for increasing bank’s profitability ?

Q 23. Arrange the following items into an income statement. Label each item, place it in the appropriate category and determine the bank’s bottom-line net income.

a. Interest paid on Term deposits Rs.100,000/-b. Interest paid on Certificate of deposits Rs.101,000/-c. Interest received on GOI Securities Rs.44,500/-d. Fees received on selling of insurance and mutual funds

Rs.23,000/-e. Dividends paid to Shareholders of Rs.0.50 per share for 5,000

sharesf. Provision for loan losses/NPA provision Rs.18,000/-g. Interest and discount on loans Rs.1,89,700/-h. Interest paid on SB accounts Rs.33,500/-i. Interest received on Corporate/PSU bonds Rs.60,000/-j. Employees salary and benefits Rs.1,45,000/-k. Purchase of a new Computer system Rs.50,000/- (Depreciation

for the current year Rs.10,000/-)l. Service charge/commission receipts from customer accounts

Rs.41,000/-m. Occupancy expenses for the bank building Rs.22,000/-n. Taxes of 34% of taxable income are paido. Safe Deposit Locker rent receipt Rs.15,000/-

Q 24. M/s XYZ Bank Ltd. has the following Balance Sheet & Income Statement.

(Figures are in Rs. Crores) Balance Sheet

Liabilities & Equity Assets Assets Demand Deposits 47,000

Cash & Bal. with RBI 9,000

Term Deposits 89,000

Bal. with Banks/Moneyat call & short notice 42,000

Debentures 19,000

Investment securities 23,000

Total Liabilities 155,000Paid up Equity Capital 12,000

Loans & advances 90,000

Share Premium 4,000

Fixed assets 15,000

Retained Earnings 12,000

Other assets 4,000

Total Liabilities & Equity 183,000

Total assets 183,000

Income Statement

Interest & discount on Loans 9,000Interest on Investment securities 4,000Interest on Money Market Securities

6,000

Interest on deposits in banks 1,000Total Interest Income

20,000Interest on Deposits 9,000Interest on debentures 2,000 Total Interest Expense

11,000 Net Interest Income 9,000Non-interest/Other Income 2,000 Non-interest/Other Expense 1,000 Operating Profit 10,000Provision for loan losses/NPA Provision

2,000

Profit before tax 8,000 Tax paid 3,000Net Income/Net Profit(Profit after tax)

5,000

For XYZ Bank, calculate :

a. ROEb. ROAc. EM (Equity Multiplier)d. ER (Efficiency Ratio)e. AUf. PM

Q 25. What is the difference between firm-specific credit risk and systematic credit risk ? How can a Bank alleviate firm specific credit risk ?

Q 26. What is the process of asset transformation performed by a Bank ? Why does this process often lead to the creation of interest rate risk ? What is interest rate risk ?Q 27. What is refinancing risk ? How is refinancing risk part of interest rate risk ? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest ? A decrease in the rate of interest ?

Q 28. What is reinvestment risk ? How is reinvestment risk part of interest rate risk ? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest ? An increase in the rate of interest ?

Give Answer to Question Nos. 1 to 30 in a couple of words. Each question carries 1 mark.

Q 1. What is the process of pooling small amounts of savings from individuals to be given as loans known as------ ?

Q 2. What is the process of borrowing of relatively short-term funds from savers, who often cannot commit their funds over long periods, and making long-term loans to borrowers who require a long-term commitment to funds known as ?

Q 3. What is the limit/amount of deposit insurance available to a single individual depositor per bank ?

Q 4. All scheduled commercial banks are required to deposit a certain percentage of their Net Demand and Time Liabilities in the form of cash with RBI. What is the name of this and the current rate ?

Q 5. Expand SWIFT ?

Q 6. Expand RTGS ?

Q 7. Name two non-fund based credit facilities commonly provided by a commercial bank ?

Q 8. Name the right of a banker to combine/adjust two accounts of a customer, one with a credit balance and the other with a debit balance ?

Q 9. Name the right of the Banker to retain possession of the goods & securities owned by the debtor (borrower) until the debt due from the latter is paid ? Q 10. Name the bill finance facility under which Buyer’s Bank discounts the bill for the account of the Buyer and remit the amount to the Drawer/Seller of the Bill and Buyer’s Bank recovers the amount paid on the bill along with interest and other charges, if any from the Buyer (his Customer) on the due date of the bill. This is a working capital facility to the buyer as an alternative to the Cash Credit facility against stocks.

Q 11. What is the name of a bill which is payable after a specified period of time ?

Q 12. Name a credit facility which is a substitute of a Term loan and also a non-fund based credit facility ?

Q 13. In countries like USA and Japan, issue of bank guarantee is prohibited, instead the banks there issue a specific type of Letter of Credit for this purpose. Name this Letter of Credit ?

Q 14. Write the expression for Working Capital Gap (WCG) ?

Q 15. Write the expression for Tangible Net Worth (TNW) ?

Q 16. Current ratio is 1, find out the Net Working Capital (NWC) ?

Q 17. THIS IS A SIMPLE METHOD OF WORKING CAPITAL ASSESSMENT WHERE THE WORKING CAPITAL REQUIREMENT OF THE BUSINESS UNIT TO BE ASSESSED AT 25% OF THE PROJECTED ANNUAL GROSS SALES FOR THE NEXT YEAR. NAME THIS METHOD ?

Q 18. Define Margin of Safety (MoS) in relative form which is used as tool in Term loan appraisal.

Q 19. In loan syndication, a borrower is liable to pay a charge which is certain percentage on the undrawn/unutilized portion of the loan. Name this charge ?

Q 20. In a loan transaction, very often borrower has got better information than the banker. This situation is known as ------ ?

Q 21. After loan is availed by the borrower, very often borrower indulges in irresponsible or problematic behavior which may lead to negative outcome. This situation is known as ------------- ?

Q 22. Define Net NPA to Net Credit Ratio ?

Q 23. What is the NPA provision rate for Loss Loan Asset ?

Q 24. What is the maximum default period beyond which a loan account will be classified as NPA in the books of the bank ?

Q 25. Name the new risk recognized in Basel II ?

Q 26. What is the minimum Capital adequacy ratio (CAR) for Banks in India as per Basel II ? Q 27. Sub-ordinated debt is a part of Tier I or Tier II capital ?

Q 28. BCBS defines one risk as “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events”. This risk is called as --------- ?

Q 29. When the asset of a bank is short funded (borrowing short, lending long), this gives rise to a risk which is a particular form of interest rate risk. Name this risk ------ ?

Q 30. Name the ratio used for assessing the repayment capacity of a borrower in case of a Term Loan ?

Q 31. If a Bank funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest ?

Q 32. When the asset of a bank is long funded (borrowing long, lending short), this gives rise to a risk which is a particular form of interest rate risk. Name this risk ------ ?

Q 33. If a Bank funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest ?

Q 34. Who decides interest rate on Savings Bank account ?

Q 35. What is the current interest rate on Savings Bank account ?

Q 36. What is the interest rate payable on Current Deposit account ?

Q 37. Who decides interest rate on Term Deposit account ?

Q 38. What is the full form of BPLR ?

Q 39. Who decides the BPLR of a Bank ?

Q 40. Define the Rate Sensitivity Gap (RSG) also known as Re-pricing Gap or Funding Gap ?

Q 41. What are the three pillars of Basel II new capital accord ?

Q 42. What is the new risk introduced as per Basel II ?

Q 43. Define Capital Adequacy Ratio (CAR), also known as Capital to risk-weighted asset ratio (CRAR).

Q 44. What are the two reasons for Which banks need liquidity ?

Q 45. What two methods do Banks/Financial Institutions use to manage the liquidity needs ?

Q 46. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest rates for the following position :RSA = 100 crore, RSL = 50 crore

Q 47. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest rates for the following position :RSA = 50 crore, RSL = 150 crore

Question Nos. 1 to 6 carry 5 marks each.

Q 1. Mention the different items that appear in a Bank’s Income Statement (Profit & Loss Account) in India. Show step by step calculation to derive Operating Profit and Net Profit after tax (Net Income).


Q 7. What are three pillars of Basel II new Capital accord ? What is the new risk introduced as per Basel II ? Define Capital Adequacy Ratio, also known as Capital to risk-weighted asset ratio (CAR or CRAR). What is the minimum Capital adequacy ratio requirement for Banks in India ?

Q 8. What is Credit Default Swap (CDS) ? Explain with the help of a diagram.

: : 2 : :

Q 9. M/s XYZ Bank Ltd. has the following Balance Sheet & Income Statement.

Balance Sheet (Figures are in Rs. Crores) Liabilities & Equity Assets Assets

Demand Deposits 57,000 Cash & Bal. with RBI 19,000Term Deposits 99,000 Bal. with Banks/Money

at call & short notice 52,000Debentures 29,000 Investment securities 33,000Total Liabilities 185,000Paid up Equity Capital 22,000 Loans & advances 110,000Share Premium 14,000 Fixed assets 15,000Retained Earnings 12,000 Other assets 4,000 Total Liabilities & Equity 233,000 Total assets 233,000

* Average earning assets = 200,000

Income Statement

Interest & discount on Loans 19,000Interest on Investment securities 5,000Interest on Money Market Securities 6,000 Interest earned on deposits in banks 1,000Total Interest Income 31,000Interest paid on Deposits 10,000Interest paid on debentures 3,000 Total Interest Expense 13,000 Non-interest/Other Income 4,000 Non-interest/Other Expense 6,000 Operating Profit 16,000Provision for loan losses/NPA Provision 3,000Profit before tax 13,000 Tax paid 3,000Net Income/Net Profit(Profit after tax)

10,000

For XYZ Bank, calculate :

a. NIMb. ROEc. ROAd. EM (Equity Multiplier)e. AUf. PM

Q 10. Explain the Letter of Credit (LC) Mechanism by means of a diagram.

-----------------End of Question Paper--------------

Q 4. Why banks need liquidity ? What two methods do Banks/Financial Institutions use to manage the liquidity needs ?

Q 5. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest rates for the following positions :

a. RSA = 100 crore, RSL = 50 croreb. RSA = 50 crore, RSL = 150 crorec. RSA = 75 crore, RSL = 70 crore

d. What conclusions can you draw about the re-pricing model from the above results ?

: : 2 : :

Question Nos. 9 & 10 carry 10 marks each.

Q 10. (a) As per the duration gap model of interest rate risk management, the change in the Market Value of the Equity (MVE) of an FI is given as under :

∆ E = - DGAP x A x ,

(Where the symbols have usual meanings as underChange in E = - Adjusted duration gap x Asset size x Interest rate shock)

Derive the above formula and explain the effect of the above three factors on the market value of the FI’s equity due to interest rate volatility.

(b) If the market values of assets and liabilities are Rs.2,400/- Crore and Rs.2,100/- Crore respectively, compute the change in the market values of equity given the following information :

Duration of Assets 5 years

Duration of Assets 4 years

Interest rate 11%

Change in Interest rate + 1%

-------------------END-------------------------


Q 7. The following information relates to the assets of a bank :

Nature of Asset Amount (Rs. in Crore)Standard Asset 5,600Sub-Standard Asset :Secured ExposureUnsecured Exposure

2,1501,000

Doubtful Asset :up to 1 year 1 – 3 yearsabove 3 yearsLoss Asset

1,200 480 220 150

Additional information :(i) Standard asset carries a provision of 0.40%(ii) The proportion of security available for the doubtful assets is 65%, 40%

and 25% for the three categories respectively.

Calculate the provisioning requirement of the bank based on the above information.

: : 2 : :


Q 9. Classify the following accounts into one of the following categories : (a) assets (b) liabilities (c) equity (d) revenue (e) expense (f) Off-Balance Sheet (OBS) activity.

(1) Retail Deposits (2) Paid-up-capital (3) Loan Commitments (4) Consumer loans (5) Interest on Investment securities (6) Interest on Savings Bank Deposits (7) Current Deposits (8) Letter of Credit (9) Retained earnings (10) Provision on NPA Loans


Q 16. What is refinancing risk ? How is refinancing risk part of interest rate risk ? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest ? A decrease in the rate of interest ?

Q 17. What is reinvestment risk ? How is reinvestment risk part of interest rate risk ? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest ? An increase in the rate of interest ?

Q 18. Arrange the following items into an income statement. Label each item, place it in the appropriate category as per the Bank’s Income Statement (P & L A/c) format and determine the bank’s bottom-line net income.

p. Interest paid on Term deposits Rs.100,000/-q. Interest paid on Certificate of deposits Rs.101,000/-r. Interest received on GOI Securities Rs.44,500/-s. Fees received on selling of insurance and mutual funds Rs.23,000/-t. Dividends paid to Shareholders of Rs.0.50 per share for 5,000 sharesu. Provision for loan losses/NPA provision Rs.18,000/-v. Interest and discount on loans Rs.1,89,700/-w. Interest paid on SB accounts Rs.33,500/-

x. Interest received on Corporate/PSU bonds Rs.60,000/-y. Employees salary and benefits Rs.1,45,000/-z. Purchase of a new Computer system Rs.50,000/- (Depreciation for the current

year Rs.10,000/-)aa. Service charge/commission receipts from customer accounts Rs.41,000/-bb. Occupancy expenses for the bank building Rs.22,000/-cc. Taxes of 34% of taxable income are paiddd. Safe Deposit Locker rent receipt Rs.15,000/-

Q 8. ABC bank has 11.75% as its average cost of funds. If the transaction cost involved for credit accommodation is 0.5% and if the bank plans to maintain a 3% margin on the same, compute the contractual rate for the loan which is adjusted for loan defaults and losses. Following additional information for the problem : Principal loan amount – Rs.1,500/- crore, Probability of repayment – 0.9, Recovery rate for the principal and interest component – 0.95.

Case Study 1

Read the case let carefully and answer the following questions. Each Answer should be specific/to the point and not to exceed 4 to 5 lines.

Axis Bank has to control cost of funds improve bottomline(ET dtd.12.01.09)

Q 10. Define Net Interest Income (NII), Net Interest Margin (NIM) and Burden or Overhead.

Q 11. What do you mean by CASA deposits ? Why is it so important for a bank ?

Q 12. Comment on the statement “Falling interest rates affect lending rates rather than the borrowing or deposit rates”.

Q 13. What are the sources of other income for a bank ? Why it’s so important for the bank in the present environment ?

Q 14. What are the sources of other income for a bank ? Why it’s so important for the bank in the present environment ?

Q 15. Comment on the statement “The amount provided under the head of provisions and contingencies fell by 34% Y-o-Y due to reversals of provisions on corporate and government bonds, amounting to Rs.147 crore boosting its profit growth. In fact, this is the most crucial aspect of the results, where the profit growth is more on account of drop in provisions than the growth in net interest income (NII).”

Q 16. “Going forward, the cost of deposits is expected to come down that would ease the pressure on NIM”. Explain this statement.

AXIS Bank reported a 63.2% growth in net profit for the quarter ended December 2008 on growing business and a sharp drop in provisions and contingencies. Bank’s business as measured by the sum of deposits and advances grew by 54.5% year-on-year (Y-o-Y). This was in line with the trend seen in the first half of the financial year 2009. Net interest margin (NIM) fell by close by close to 79 basis points (bps) to 3-12% for the December quarter, as term deposits posted a growth of 75%, while CASA deposits grew by just 29%. Term deposits attract higher interest than CASA deposits. The bank also reduced interest rates after the RBI’s rate cuts. Falling interest rates affect lending rates rather than the borrowing or deposit rates. Therefore, it was expected that bank’s NIM could be affected, though the change was substantial and it is extremely crucial for Axis Bank to control its rising cost of deposits. Other income rose by 50% Y-o-Y on strong momentum in fee income which grew by 56.7% and trading gains.

The amount provided under the head of provisions and contingencies fell by 34% Y-o-Y due to reversals of provisions on corporate and government bonds, amounting to Rs.147 crore boosting its profit growth. In fact, this is the most crucial aspect of the results, where the profit growth is more on account of drop in provisions than the growth in net interest income (NII), which stood at a mere 24.4% against 70.8% during the six months ended September 2008. The positive aspect of the third quarter result is that the bank is still posting a very high growth on its loan book. The performance at the operating level is satisfactory. The key concern is high cost of deposits. The bank has to control its cost of funds, as it may affect its bottomline growth in coming quarters. Going forward, the cost of deposits is expected to come down that would ease the pressure on NIM. And if this happens,

the bank would continue to post high growth rates in profit as seen in the first nine months of the financial year 2009.

Case Study 2


Arcil to float USD600-m fund to invest in NPAs(ET dtd.19.01.09)

Q 10. What do you mean by asset quality/credit quality ? How the asset quality of a bank is measured ?

Q 13. Why the banks have voiced concerns over the impact on their asset quality in the present situations ? Q 13. What is the difference between firm-specific credit risk and systematic credit risk ? How can a Bank alleviate firm specific credit risk ?

Q 14. Define loan sales. What is the difference between loans sold with recourse and without recourse from the prospective of both sellers and buyers ?

ARCIL, the country’s first asset reconstruction company, is looking to float a USD600-million fund for investing in distressed bank assets, said managing director & CEO of the Company S Khasnobis. Arcil has proposed to contribute 20% of the fund and the balance would be raised from International and Domestic investors. The company will float the product in next three months and the funds would be raised in phases on the basis of requirement. “The fund will be used for cash purchases of NPAs from banks”, Mr. Khasnobis said here on Saturday on the sidelines of the 4th international convention of the Association of National Exchange Members of India. With the latest proposal to float a fund, which would be used to finance its cash purchases, Arcil is certainly positioning itself for a better business prospect next fiscal.

Given the economic downturn, every top banker has voiced concerns over the impact on their asset quality. They expect NPAs to rise from the current levels. This is an opportunity for Arcil to grow its business. Arcil buys bad loans from banks and expedite recovery of the amounts locked in NPAs. Sectors like exports, textiles, gems and jewellery, logistics have faced severe stress following the slowdown and these sectors are likely to contribute most in the rise of NPAs. As job cuts have also become a regular affair now, banks may also face rise in NPAs in their housing loans. Arcil has recently started purchasing distressed assets, especially bad home loan assets. However, its main focus continues to be buying the distressed corporate loans from banks.

Case Study 3


Treasury loss : Rs.1,500 CrorePSU Banks to take a major hit due to rising yields

(ET dtd.28.06.08)

Q 11. What do you mean by mark-to-market (MTM) ?

Q 10. Mention the three categories of investment securities held by banks based on the objectives of investments.

Q 13. Out of this which categories of investments are subjected to Mark-to-market (MTM) accounting ? And what is the frequency of MTM for such categories ?

Q 6. Whatare objectives of an investment portfolio of a bank ? Q 13. “Banks run into losses on their bond portfolios, when bond yields rise sharply. Thus, in the current circumstances, banks with a larger share of portfolios in the AFS category (non-HTM bucket), and that too, bonds with a longer duration, will be most affected.”

The first quarter of 2008-09 could see banks declare losses up to Rs.1,500 Crore on treasury operations. Nationalised banks are more likely to bear the brunt of rising yields compared to their private sector peers since a few large PSU banks have perked as much as 50-60% of their bond portfolios in the available-for-sale (AFS) category. As against this, private sector majors such as ICICI Bank, HDFC Bank and Axis Bank have perked only 15-20% of their bond portfolios in the AFS bucket. As per RBI guidelines, banks have to mark-to-market (MTM) a portion of their G-sec book (i.e., 26-30% of assets owing to high SLR), which is in the non-held-to-maturity (HTM) category. Thus, in the current circumstances, banks with a larger share of portfolios in the AFS category (non-HTM bucket), and that too, bonds with a longer duration, will be most affected. In addition, banks have also to mark-to-market all their non-G-sec investments (like corporate bonds) every quarter.

According to a recent report published by Merrill Lynch, for every 10-basis points rise in yields, banks could incur a loss of up to Rs.250 Crore. It may be recalled that the yield on the benchmark paper, the 8.24% bond maturing in 2018 (residual maturity of 10 years), has moved up from 7.90% in March 2008 to over 8.85% in June 2008. Banks run into losses on their bond portfolios, when bond yields rise sharply. Bond prices fall when yields rise and banks have to mark-to-market the holdings in the AFS category based on the yield prevailing on the last day of the quarter. Recently, the RBI hiked repo rate – rate at which banks borrow from RBI – and the CRR by 50 bps each. This has caused yields to move up drastically in the past week of this quarter. Given the PSU banks have large SLR requirements, most banks would have huge stocks of the benchmark bond, which alone has witnessed a fall of more than 400 paise rise in barely three months time. SBI, the largest PSU player, seems to be the worst hit, given the significant exposure to varied class of securities. The bank has parked up to 80% of its bond holdings in the HTM category, but faces the risk of incurring a loss of more than Rs.350 Crore this quarter.

CBM Question Bank

Documents

Transcript of CBM Question Bank