AIM 2: Discuss the potential moral hazard issues associated with fixed-rate deposit insurance.

1、The existence of deposit insurance is most likely to:

A) decrease the incentive for the banks to shift credit risk to FDIC.  

B) increase the capital requirement for the bank.  

C) decrease the need for external monitoring. 

D) increase the moral hazard problem between depositors and regulators.

The correct answer is D

Deposit insurance increases the bank’s risk taking behavior by shifting potential losses to FDIC. Hence, the bank is likely to take riskier loans than if it had to bear the full cost of defaults.

2、 A moral hazard problem associated with Federal Deposit Insurance Corporation (FDIC) deposit guarantees is that such insurance is likely to:

A) decrease incentives of depositors to monitor the financial strength of banks. 

B) increase risk-taking behavior on the part of banks. 

C) increase the risk of depositors. 

D) be unavailable for low income depositors.

The correct answer is B

The moral hazard problem refers to the fact that banks have more incentives to take on additional risk, because the FDIC effectively subsidizes losses due to the increased risk.

AIM 3: Discuss the benefits and weaknesses of the original 1988 Basel Accord.

1、The minimum capital requirement under pillar I of the new Basel Capital Accord is:

A) 6% of risk-weighted assets. 

B) 8% of risk-weighted assets. 

C) 4% of risk-weighted assets.

D) 2% of risk-weighted assets.

The correct answer is B

BIS uses the Cooke ratio to require capital equivalent to 8 percent of risk-weighted assets.

2、The Basel II Accord generates overall capital requirements that should be:

A) higher than the level indicated by the first Accord. 

B) lower than the level indicated by the first Accord. 

C) less sensitive to a bank’s risky activities. 

D) similar to the level indicated by the first Accord.

The correct answer is D

Basel II attempted to generate overall capital requirements that were similar to the level indicated by the first Accord, but more sensitive to the bank’s risky activities.

3、The original focus of the 1988 Basel Accord was

A) Market risk. 

B) Credit risk. 

C) Operations risk. 

D) Interest rate risk.

The correct answer is B

Originally, the Basel Accord focused primarily on credit risk.

AIM 4: Identify the primary goals of the Basel Committee in developing the Basel II Accord.

1、All of the following are pillars of the New Accord, EXCEPT:

A) post 9/11 contingency planning. 

B) supervisory review. 

C) minimum capital requirements. 

D) market discipline.

The correct answer is A

The three pillars of the New Accord are minimum capital requirements, supervisory review, and market discipline.

2、Which of the following is NOT one of the three pillars of the new Basel Capital Accord (Basel II)?

A) Reduced regulatory burden. 

B) Public disclosure. 

C) Supervisory review of capital adequacy. 

D) Minimum capital requirements.

The correct answer is A

The three pillars are: (1) minimum capital requirements, (2) supervisory review of capital adequacy, and (3) public disclosure.

3、Which of the following are pillars central to the Basel II Accord?

      I. Supervisory Review Process.

     II. Standardized Approach.

    III. Minimum capital requirements.

    IV. Market risk weighting.

A) II and IV. 

B) I and III.

C) I, III and IV. 

D) II, III and IV.

The correct answer is B

The three pillars are minimum capital requirements, Supervisory Review Process, and market discipline.

AIM 5: Describe how the necessary components for calculating capital requirements are determined under the standardized and internal ratings-based approaches.

1、For banks that use the advanced internal ratings-based (advanced IRB) approach to credit risk, the primary inputs to the capital calculations are:

A) credit assessments of external rating agencies. 

B) the banks’ internal assessments of key risk drivers. 

C) mandated by bank supervisors. 

D) interest rates.

The correct answer is B

Under the advanced IRB approach, the bank uses its own internal measures of credit risk and exposure in capital calculations.

2、The advanced internal ratings based (IRB) approach to calculating risk weights differs from the foundation IRB approach in that the advanced approach:

A) relies on external estimates for most risk parameters. 

B) allows for internal estimates of loss given default (LGD) and exposure at default (EAD). 

C) offers less flexibility in estimating risk parameters.  

D) allows for internal estimates of probability of default (PD) and exposure at default (EAD). 

The correct answer is B

The advanced IRB approach offers more flexibility, because it does not rely on external estimates of risk parameters. Both the foundation and advanced approaches allow for internal estimates of PD, but the foundation approach uses external estimates for all other parameters.

3、Basel II does NOT allow calculation of risk-based capital under the:

A) external probability approach. 

B) internal ratings-based advanced approach. 

C) internal ratings-based foundation approach. 

D) standardized approach.

The correct answer is A

There is no such approach denoted “external probability.”

4、Under Basel II, collateral is deducted from exposure at default (EAD) under which approach to calculating capital requirements?

A) Foundation IRB approach. 

B) Advanced IRB approach. 

C) All of these.

D) Standardized approach.

The correct answer is D

Only the standardized approach allows collateral to be deducted from exposure at default (EAD).