What is banking loan default. Write offs usually occur at once, rather than being spread over 3.
ult. Write offs usually occur at once, rather than being spread over 3. Sensitivity test: Effect of interest rate changes on equity and CET1 capital:
Establishment authorized by a government to accept deposits, pay interests,
act as intermediary in financial transaction and provide other fin. services
Bank is the connection between customers that have capital deficits and
customers with capital surpluses
Bank’s role in the economy:
Liquidity: Intermediary between clients with excess of liquidities with clients
short of liquidities Deposits: secure clients deposits and provide loans
Transactions: facilitates payments. Safekeeping: of assets
Banks business model  low in High out
Different types of banks
Central bank: monetary policy and control of money supply, banks
supervision for safety and soundness, set interest rates Commercial bank:
acceptance of deposits, house or business loans, overseas trades, interbank
market (BCV) Investment bank: share & bonds issuance, secondary market
dealing for equity & bonds, broker, market maker, M&A advices Private bank:
tailored financial services (wealth management and asset servicing), financial
planning, advisory services, portfolio management
Main differences between bank & industry
BS: Goodwill, int. assets, PPE vs loans & tradings, higher leverage in banks,
D/E ratio higher in banks  low equity due to customers deposits IS: sales vs
interest income, commission income, personel  Loan book always at
amortized cost
Analyzing banks FS
Retail bank: Focus on deposits & mortgages, low cost-funding, smaller than
commercial bank and more community focused Issues: efficiency (larged FC)
& capital adequacy
Main characterisitcs: prêt à la clientèle, fonds clientèle, limited distinction
between Cur. Assets and NCA, liquid A & L, high leverage, fidelity is key,
interest income = operating performance, non-interest income is weak
Commercial bank: hold wider range of assets (loans, mortgages, due from
banks), liability are mainly deposits, highly leveraged (individuals &
companies), income driven by interest income & service fees Investment
bank: makes money from bid-ask spread, much less customers than previous
banks, active in trading Main characteristics: financial instrument is the most
important category due to complex activities, major focus on trading, wholesale
funding, Private bank: relatively short BS, moderate engagement in loan, not
active in trading  more conservative, largerly funder through wealthy
customers deposits (UHNWI)
Main risks banks are facing
Credit risk: borrower or counterparty fail to meet its obligations in accordance
to contract, applies for all banks types, major threat for banks (commercial &
retails) with loans. Denotes 2 uncertainty aspects: principal value & interest
income
Market risk: possibility of decline in the market values of assets or earnings
that arise from changes in market variables. Interest rate, FX, other market
risks, equity price, bonds, commodity, FX  CR, MR & LR are measurable,
manageable
Liquidity risk: risk that a bank will not be able to refinance assets as liabilities
become due, correlated with IRR  IR higher, depositors put more money in
the bank, LR measured by tracking of maturity and CF mismatches, 2
objectives with liquidity measurement: reveal liquidity position, examine how
position evolves under different scenarios and assumptions
Legal risk: the bank breaches local regulation
Reputational risk: bank is engaged in op. criticized by public
Operational risk (encounters failure internally): 3 lines of defense mode:
employees (training, standard & procedure), risk compliance & commitees,
external audit
Credit risk: Borrower risks: constant over time
Main risk: due from banks, loans, int. earnings deposit banks
Credit risks – counterparty risk:
One party in a contract fail to meet obligations
Risk: credit losses if counterparty default, replacement cost risk (less favorable
terms), potential exposure  current mark-to-market + future potential
exposure
The 5C’s for credit analysis
Character: credit & trust worthiness Capacity: CF forecast & profit projection
Collateral: 80% AR, 50% inventory Condition: degree of comp / macro
factors Capital : equity level & capital commitment
How to quantify credit risk
CR = PD X EaD X LGD
The higher the rating grade, the lower the PD
How to account for credit risk of loans
Provision for loan losses (PLL): classified as expense (I/S), reflects change in
ALL for assets held during the period OR initial assessment of ALL for assets
acquired in the period.
Allowance for loan losses (ALL): (BS) estimates of uncollectible amounts
used to reduce the book value of loans to the amount that a bank expects to
collect; reflects estimate of future credit losses on its loans outstanding, contra-
asset to loans outstanding, referred to the total reserve/provision for bad debts.
Loan impairment: when it is not likely that lender will collect the full value of
the loan, loan is adjusted to recovery value, Impairment is strongly linked to
also called “loan default”.
Loan charge-offs (LCO), Loan write-off: are recorded when loans are deemed
uncollectible (> 180 days or 6-m of non-payment), reflect the realization of
Capital buffer (2.5%)  standard = CET + AT1+T2 +cap
several periods.Non-performing loan (NPL): is a loan that is in default or
close to being in default - Many loans become non-performing after being in
default for 90 days (depend on specific contract terms)
 Beginning ALL – (benefit/provision) unfunded commitment + PLL – total
LCO + recoveries LCO = ending ALL
Expected losses model under IFRS 9
Stage 1: performing loans: CR has not increased, 12 mth ECL
Stage 2: underperforming loans: CR has increased, recognize lifetime ECL,
interest revenue on gross basis
Stage 3: non-performing loans: credit impaired asset (IAS 39), lifetime ECL,
interest revenue on net basis
How to disclose Credit Risk
Qualitative disclosure: risk exposures for each type of financial instrument,
management objectives, policies, and processes to manage risks, changes from
the prior period
Quantitative: maximum amount of exposure (before deducting collateral
value), for fin. Asset past due or impaired analytical disclosure
At Amort. Cost: net carrying value is the max. exposure to credit risk // at
FVOCI: ALL does not reduce car. Amount. The Car. Amount is the max.
exposure to credit risk
How to analyze bank acc. quality for credit losses: 4 steps
1. identify the items sensitive to credit risk (on-off balance sheet items) off
balance sheet items also subject to credit risk
2. assess bank’s loan portfolio quality and loan reserve adequacy: 2 ratios:
2a: ALL (Wo unfunded commitment reserve) / NPL ratio: rises with estimates
of PD and exp. Losses  ≥1 // pour le 2b prendre le même ALL
2b: ALL /net LCO (net charge of) represents how many years of future charge-
offs bank has reserved for  loss during the year  loans become NPL after
90 days  homogenous (consumer) & heterogenous (commercial) loans
4. access the accounting discretion for loans  manage income and capital
How do banks mitigate credit risk (Collateral, Guarantees, Credit defaut
swap & loan covenant)
BoD delegates responsibility to Credit Committee (CRO), formulate credit
policies, authorization structure for approval and renewal of credit, review and
asses risks, limit exposures, apply internal risk grading system, internal audit.
Objective: understand how banks can manage and/or reduce credit risk
Market risks (MR): arise from movements in market risk variables
Part of market risk: equity, interest rate, currency & commodity risk
Market risks - Interest rate risk (IRR)
Sensitivity of financial instrument and others exposure to unexpected change
in interest rates, price to borrow / lend money for a period of time, more
difficult to manage than other market risks arising from variables (equity,
commodity, FX)  time until cash collected & variability of IR
If interest rate increases, price of bond increases
Int. rates depend on many factors (macro, expected inflation rates, credit risk of
borrower  varies over time, yielding gains or losses. 2 types of IR contracts:
fixed & floating
Spot interest rate Assets (loans) Liabilities (debt)
Rises Bank benefits Bank is hurt
Falls Bank is hurt Bank benefit
More value volatility when: time to maturity is longer, IR more variable IR
drives volatility of: CF floating rate & value of fixed rate fin. Instrument
When IR changes  Floating CF change not value  Fixed opposite
Imperfectly floating rate: some CF change & some value change
Accounting for Market risk
Trading book: part of institution portfolio  ST profits for hedging MR
Trading accounts: highly liquid and traded frequently  (use of FV),
typically marked-to-market  BS immediately impacted by market risk
Banking (non-trading) book: part of inst. Portfolio  LT investment  due
to equity, IR, currency, commodity risk Investments accounts: less liquid and
often held until maturity  arise in banking book & from off-balance sheet
items
Impacts of MR on banks FS  affect earning & capital
MR exists in both individual & portfolios transactions, correlated with CR. MR
affect on/off balance sheet items
MR mainly related to bank trading & investing activities
Type of bank’s books: trading (sensitive), banking (less sensitive)
Regulatory requirement on MR, impacts on Basel III ratios:
Capital ratio: capital components decrease, RWs for MR increase
LCR: decline in HQLA, increase in expected net cash outflow for 30d stress
NSFR: carrying value of capital down, available amount of stable funding up
 from regulatory perspective, MR affects banks reg. capital calculation &
liquidity
Reg. valuation adj, Prudential valuation adjustment (PVA)
May be required to the valuation uncertainty associated with types of position
and changes in the value of pension fund asset & liabilities.
PVA is subject to all fair-valued asset including estimates of expected Credit
losses
2. Independent price verification process: Market Risk and Product Control
department verifies fair value estimates independently using market prices and
other sources.
LEVEL 2  limit max 40% of HQLA
Interest rate changes do not affect the carrying amount of assets and liabilities
at amortized cost but can impact the interest income or expense recognized in
the income
Market risk management & mitigation
Exposure identity & measurement (IRR, equity, FX, commodity, liquidity).
IRR management: matching exposure (ALM), holding floating rate mortgage,
securitizing fixed rate mortgage, using IR derivatives. Org. setup: AML, MR
management department, Front, middle, back-office. Derivative / hedge risk
reduction: aggregation, pricing, portfolio. Governance & control: regulatory
check, policy control, coordination objective: manage & reduce MR
Market risk disclosure and reporting
Required by: US GAAP, Basel III, Pillar 3 report
Like credit risk, MR can use 2 approaches (Standard & A-IRB)
Calculation of RWA for MR affect bank’s regulatory capital
Banks can disclose exposure to each type of MR using the Value at risk (VaR)
impact of market risk on banks reporting: Fin. Asset at FVOCI, PVA,
regulatory cap ratio, items in trading book
Concept of Value at Risk
3 inputs are needed: confidence level (95-99% with 1.65 or 2.33 std), time
period over which the risk is to be estimated (daily, monthly, yearly), the
volatility in asset values (10% loss / day, month, year) Methods to calculate
VaR: Historical, Variance-Coverage, Monte-Carlo Sim
Overview of banks reporting for market risk
Tabular format: less processed and more disaggregated data  freedom
Sensitivity & VaR: aggregate risk measures  hard to interpret without
knowledge, VaR provides the maximum likely for given period based on
Confidence interval (CI)
Fraud risk (pressure, rationalization, opportunity)
Internal fraud: linked to an employee or boss
External fraud: fake bills
P&L: inflate revenues, decrease expense, wrong period
BS: fail to record prov, missing inventory or record fictive assets
Fraud risk – Money laundering:
Placement phase: collection of dirty money that integrates financial system
Layering phase: transformation of fund to get rid of “dirty”
Integration phase: give a legal appearance to the money and buy stuff with it
Risk management and asset liability management (ALM)
3 objectives of asset management: risk, liquidity, return
Liability: diversification of financing sources: 1. Depositors, 2. Wholesale, 3.
Sophisticated market
Asset & liability committee (ALCO): coordinates decisions on sources of
funding and acquisition of assets across the bank by taking risks into account
Asset & liability gap: identify if there is a gap between them
Basic gap: Qty rate sensitive liability is deducted from asset
Maturity gap: split fixed vs floating A & L into different maturity buckets
ALM can manage liquidity & market risk (most importantly Interest rate risk,)
Legislation & Regulatory Authorities–banking governance
FINMA: supervising authority for banks & other fin. Intermediaries, focus on
strengthening the protection of individuals and the proper functioning and
stability of overall financial system. Role of central bank: everything related
to monetary policy and has the exclusive right to issue Swiss banknotes and
coins, duty to control monetary supply and provide CHF market with liquidity,
also responsible for facilitating and securing operation of cashless system
Other supervisors of banks: External auditors, SIX, self-regulated supervision
& licensed supervisory org. (asset managers)
Licences required to conduct banking services:
Banks must obtain authorization from FINMA before doing business operation.
3 types of licences:
Banking licence: can take deposits > 100mio from the public on professional
basis (>than 20 people)
Fintech licence: (light licence), for companies involved in financial sector that
accept public deposits on commercial basis up to 100 mio
Securities firm licence: engage in the business of securities trading or
underwriting securities
Application process for bank licence: submit to FINMA containing general
info about operation and supporting documentation (area of business, type of
clientele, audit attestation etc.)
Basel framework
BI: only credit risk is considered
BII: include operational, market, strategic & reputational risks + 3 pillars
approach to risk management  FW looking
BIII: capital conservation buffer + countercyclical buffer, Minimum ratio to
10.5% (previously 8%), LVG, LCR, NSFR ratio intro  FW looking
BIV: change on internal models, LVG ratio, credit valuation adj. (CVA),
operational risk frameworks
Members: central banks & supervisors banks from 28 country
3 pillars of risk management
Pillar 1: enhanced minimum capital & liquidity requirements
Pillar 2: supervisory Review process  develop and use better risk
management techniques in monitoring risk
Pillar 3: enhanced risk disclosure & market discipline
Droite BS: equity
-----------------------------------
Gauche BS all wo /liquidity
Eligible capital & Risk-Weighted assets (RWA)
CET1 (4.5%): share capital, disclosed reserves (ret. Earnings), reserves for
general banking risk (-deferred tax), profits carried forward, profit of current
year (-distribution / audited), minority interest
AT1 (1.5%): continuous capital instrument (no fixed maturity), preferred
shares, high contingent convertible securities
(CE)T2 (2%): evaluation reserves, subordinated term debt, general loan-loss
reserves, undisclosed reserves
Countercyclical buffer (max 2.5%) depends
Risk arising from assets:
Credit, counterparty, Non-counterparty, market, operational risk arise from
assets
Credit risk – RWA
Exposure: receivables, off-balance sheet items converted into credit
equivalents, net position in equity / int. rates instruments not held in trading
book, net position in treasury shares and qualified interest held in trading book
+ equity
2 ways for calculations: standard & IRB (sub to FINMA approval)A-IRB: the
required capital for credit is quantified through empirical model Standard
approach: bank use risk assessment prepared by external credit assessment
institutions (ECAI)  main diff is 12mth ECL, LGD, scenario
Counterparty risk – RWA:
2 important characteristics: risk of counterparty default, Credit Valuation
Adjustment (CVA) Categories of transaction giving rise to counterparty
risk are: over the counter (OTC) derivatives, exchange rate traded derivatives,
long settlement transaction, securities financing transactions
Market risk – RWA: 3 ways for calculations:
De minimis (based on CR), standard, IRB (need FINMA approval)
Standard approach:
To get min required cap: equity, FX, Gold & commodities (8%), interest
rate (annexe) if you divide by 8%  RWA for market risk
Operational risk: RWA 3 ways for calculations:
Basis, standard, advanced measures (need FINMA approoval)
Basis include (gross interest income, net result from commission business &
services, net results from trading & FV option, direct investment income from
non-consolidated equity interest, results from real estate  AVG of basis of 3
years *15% = MRC / 8% = RWA
Non-counterparty risk – RWA: properties & other tangible assets * 100% =
RWA / 8% = MCR
Minimum capital required (under Basel III)
Capital ratio depend on the supervisory category defined by FINMA
1&2 (12.9%): extremely large & complex (UBS,CS & Postfin)
3 (12%): large & complex (BCGE)  for BCV (14%)
4 (11.2%): medium sized
5 (10.5%): small banks & securities house
Concept of leverage ratio
Droite BS: equity (CET1 + AT1)
--------------------------
Gauche BS: everything + off BS items total
Non-risk based backstop
Concept of liquidity requirement (LCR)
Gauche BS: liquidity + financial investment
---------------------
Droite BS : amount due to bank & customers
Aim to strengthen ST liquidity profile, defines level of liquidty buffer to be
held, CF perspectives, predefined stress scenario, time horizon (30 days) 
High quality liquidity assets have 2 level
Level 1: cash, central bank reserve, marketable securities (best quality & most
liquid), no limit to meet LCR
Level 2A: government securities, covered bonds, corporate debt securities,
corporate bonds (haircut min 15%)
Level 2B: lower rated corporate bonds, residential mortgage (haircut min 15%,
limit max 15% of HQLA)
Assets more liquid when riskiers  FALSE
Assets more liquid when issuer high credit standing  FALSE
Asset more liquid when less sensitive to Int. rate  TRUE
Asset more liquid when FX rate is low  TRUE
Concept of liquidity requirement (NSFR)
Droite BS: everything wo acc. Exp./def. income & provision
---------------------
Gauche BS: total assets (everything
Aim to strengthen medium LT liquidity profile, define min acceptable amount
of stable funding, BS perspective, predefine stress scenario, time horizon (1
year)
Available amount of stable funding: bank’s capital, preferred stock, liabilities
with maturity > 1 year
Required stable funding: weighted sum of the value of assets held and funded
by the bank including off-balance sheet exposure where the weights are RSF
factors. RSF factors: portion of an asset that could not be monetized
Regulatory capital
Due to challenging economic environment, Due to major risk exposure, banks
often exposed to asset shrinkage/debt increases
Credit risk: loan losses (impairments, write-offs), Market risk: negative
impact on trading portfolio (mainly on those securities held for trading
purposes). Operational risk: impacts on banks overall business. i.e., impact on
other assets (broker receivables). Consequence: unexpected gains /losses or
change in valuation. Objective of Basel framework is to strengthen regulation,
supervision and risk mgmt. of banking sector with focus on capital & liquidity
requirements
For swiss banks: Basel III implemented through an amendment of the Capital
Adequacy Ordinance (CAO): contains the requirements with respect to
sufficient capital to underpin the risks inherent in business, concept of loss
absorption applies to AT1 and T2 capital  (going-concern = loss absorption
 T1 & CET1) & (gone-concern = insolvency is imminent (T2)
Sources of divergence in capital ratio between accounting and regulatory:
different coverage & different definition of capital
Accounting is different from regulatory capital: financial stability concern
(Basel III aims to ensure stability and efficiency) & fair value concern
(Objective of IFRS is to provide True and fair view)
AR disclosure: main adjustment between IFRS and CET1
Minority interest, deferred tax assets, goodwill (net of tax) & intangible asset,
benefit pension fund assets, accounting adjustment under FV, investment in
own shares (treasury stock), dividend acruals, prudential valuation adjustement
(PVA)  for UBS + (A-IRB)
Regulatory capital for EU vs Swiss banks
For swiss banks, FINMA set higher capital ratios depending on the category of
the bank (1 to 5). Category 5 banks = to non-swiss bank under Basel III. TBTF
banks: must hold an extra 5.5% on RWA in the form of CET1 as a conservation
(security) buffer
Calculate shareholders equity
Share capital, additional paid-in capital (agio), retained earnings, other reserves,
minority interest
Regulatory capital management
What is derivative
Primary risks associated with derivatives: market, Counterparty, Liquidity &
interconnection (snowball effects threatening stability) risks. Why derivative:
Close relationship between values & underlying assets, easy to take short
position, more liquid and low transitions cost, financial engineer
How do banks use derivatives and banks role:
Small initial value, low liquidity req. and counterparty risks. Matching buying
and sellers: one main source of banks revenue. Banks role: End-user (hedge
risk, portfolio adjustment, speculate on market movements, arbitrage price
discrepancies), intermediary (transaction fee, bid-offer spread, trading profit,
other deal-market fee)
How to identify the type of derivative
Most investment banks have 2 purpose trading & hedge
Market making (trading) derivative: customers use derivatives to mitigate or
modify interest rate, credit, FX, equity, commodity risk
Risk management purpose: manage risk exposure using various derivatives
instruments (IR contracts to minimize fluctuations, FX to manage foreign FX
risk, Commodities, Credit derivatives to manage counterparty credit risk)

Requirements for Hedge Accounting:
1. Designation and documentation of the hedge relationship: Risk mana
objective and strategy, Hedging instrument, Hedged item, Nature of risk being
hedged, Hedge effectiveness
2. Eligible instrument 3 cum conditions: Hedging instrument (derivative.
Non-derivative fin asset or liabi at FVtPL.) / With a External party / It cannot
be split into component parts, except for separating: Time value and intrinsic
value in an option contract or Interest element and spot price in a forward
contract
3. Effectiveness requirements 3 cum conditions: (1) the existence of an
economic relationship betw the hedged item & the hedging instrument (2) the
effect of credit risk must not dominate the value changes associated with the
hedged risk (3) Hedge effectiveness is defined as the extent to which changes
in the FV or CF of the hedging instrument offset changes in the FV or CF of the
hedged item Hedge effectivness=(ΔFV /ΔCF of hedged item )/(ΔFV /ΔCF of
hedging instrument)
Hedge ineffectiveness: still required to be measured and accounted for in P&L.
Results from a mismatch of hedged item and hedging instruments arise from
different notional amount, terms, counterparty risk. Rebalancing for the
purpose of maintaining a hedge ratio that complies with the hedge effectiveness
requirements. Discontinuation when the hedging relationship ceases to meet
the qualifying criteria (after considering any rebalancing)
Securitization (titrisation):
Process of converting illiquid assets, such as loans or receivables, into tradable
securities. These securities is known as asset-backed securities (ABS)
[Customers (Principal &interest) Bank(securitize assets) SPE(Issue of
securities) Investors(Pay securities)  SPE (Funds from selling securities)
Bank(pay loan)  Customers]
Benefits: Turn illiquid assets into liquid ones; Reduce regulatory capital
requirement for the originator; Provide access to certain categories of large pool
of assets for retail investors. Drawbacks: Risk of default on underlying loans
or other assets; Lack of transparency regarding assets; Investor’s returns might
be damaged due to early repayment. Special purpose Entity/vehicle is a
subsidiary created by a parent company to isolate financial risk. Help banks
securitize assets. Tax purpose (frequently in offshore or in SPE-friendly
jurisdictions) Banks motivation and role: risk management (risk transfer),
handle potential asset-liability mismatches and credit concentrations, improves
banks return on capital and overcome profit uncertainty, provide liquidity or
lower funding cost, specialize in specific activity of lending process
How record the transaction?
1. Sale accounting: Transfers in which the transferor abandons control of the
financial assets are accounted for as complete sales of these assets, even if the
transferor retains an interest asset. Ex: transfer $100 of receivables to SPE;
Retained interest is $30 and received cash is $70 / B/S = A: receivables $200,
L: equity $200
Journal entry: Debt: Retained interest(a+) $30, Debt: Cash $70, Credit:
Receivables $100
2. Secured borrowings: Transfers in which the transferor doesn’t abandon
control of the financial assets are accounted for as secured borrowings. Ex:
transfer $100 of receivables to SPE; received cash is $70. SPE: receive $100 of
receivables. Tranche A $70, Tranche B $30
Journal entry: Debt: Cash $70 to Credit: Debt(L+) $70
Journal entry SPE: Debt: Receivables $100/ Credit: Tranche A $70/ Credit:
Tranche B $30
Mortgage servicing right (MSR):
The coupon paid by the borrower on a mortgage loan includes both servicing
compensation and a reasonable investment return to the lender.
Initial evaluation: at FV. Subsequent measurement: amortize/FV.
Interest-only strip: A bank may retain the right to a part of the interest
payments on transferred assets as compensation for servicing those assets.
Recourse obligation: An obligation for which the lender has a legal right to
seek repayment from a borrower if the collateral is insufficient to pay the debt
in full.
Example: mortgages with a book value of $100 are transferred for $98 cash,
with the following interests retained by the transferor: MSRs with a fair value
of $3, securities with a fair value of $6, and a recourse obligation with a fair
value of $2.
The transferor’s journal entry under sale accounting is:
Dr. Cash $98 / Dr. MSR(a+) $3 / Dr. Retain. Securities(a+) 6$ /
Cr. Recourse oblig (L+) $2 / Mortgages(a-) $100 / Cr. Gain sales $5
Quick ratios for type of bank
Retail / commercial: loans / total assets
Investments: FV securitization / total assets or interest income
Highest liquidity risk = higher ratio NSFR (riskier) than LCR
QCM
In a global bank, which of the following item(s) is (are) subject to the
activities of investment bank division: Commodity trade finance (T)
underwriting (T) bonds insurance (T) Mortgage (F)
For an investment bank which of the following account are relevant
Assets-backed securities (T) IPO underwriting fee (T) Deposits of
individual clients (F) / auto loans (F)
Derivative topics
Underwriting securities issued by SPE and making markets in those
securities. Providing liquidity facilities to support ST obligations of SPE
issued to 3rd party investors. Providing credit enhancement on securities
issued by SPE or market value guarantees of assets held by SPE
through the use of letters of credit financial guarantees credit default
swaps and total return swaps. Entering into other derivative contracts
with SPE. Holding senior interest with SPE. Acting a servicer or
investment manager for SPE and providing admin to SPE Servicer of
the loan (T) securities underwriter (T) financial guarantor (T) Special
purpose entity (F)
On January 1 N, a financial institution plans to buy 1’500 shares of a
corporate stock in 3 years. The current market price is $100 per share.
To lock the purchase price, the institution enters three-year stock option
contracts with a contract size of 10 shares, exercise price at $ 95 per
share, number of contracts: 12. For this financial institution, which of
the following statement(s) on this option contract is(are) correct? It’s the
hedging instrument for fair value hedge (F) It’s the hedging instrument
for cash flow hedge (T) It’s an underhedged instrument for future
corporate stocks (T) It’s the hedged item for cash flow hedge (F)
Select the statement which correctly addresses the characteristics of
derivatives. Investing in derivatives can serve speculative purposes (T)
Derivative’s notional value is often much higher than its carrying
amount (T) Derivatives can be highly risky due to leverage (T)
Derivatives provide investors with the opportunity to hedge against risks
(T)
Regarding the concept of hedge accounting, which of the following
comment(s) is (are) correct? The effect of CR must not dominate the
value changes associated with the hedged risk (T) Both derivatives and
non-derivative items can be hedging instruments (T) A holding company
can establish a hedging relationship with the subsidiary (F) If a hedging
relationship meets the hedge accounting qualification, the hedge
accounting can be applied until the contract expires. (F)
Case study topics
Deutsche Bank manages credit exposures actively by utilizing
securitization. With regard to the accounting for securitization, which
comment(s) is (are) correct? Under the sales accounting scenario,
securitized assets are derecognized from the bank's balance sheet and
transferred to a special-purpose entity (SPE) (T) The bank should
consolidate with the securitization entity if the bank holds control of
financial interests (T) The bank can use sales accounting even if it
maintains the mortgage service right (T) Under the secured borrowing
scenario, securitized assets are disclosed as off-balance sheet items. (F)
In the case of credit Suisse and Greensill Capital, which of the below
different risks you identify is(are) subject to the scandal?: compliance
(T) / operational (T) / credit risk (T) Market risk (F)
In the case of Credit Suisse and Greensill Capital, which of the
following mitigation tool(s) is(are) appropriate that may enable the bank
to mitigate compliance risk? Conduct 4eye review on the documents
signed (T) Reassessment of collateral used (F) Assess the parameters
and limits used in artificial intelligence by the fund (F) Assess solvency
risk of borrowers. (F)
Referring to the Lehman Brothers case, cite three main factors that make
the risk management system of the firm inefficient: The regulator could
play a key role in monitoring risk management to avoid the collapse of
Lehman Brothers (T) After 2006, the risk framework is not complete
and independent in decision (T) Downward pricing in real estate is the
main external factor that drives the collapse of Lehman Brothers (T)
The replacement of CRO by an incompetent person. (T)
In the annual report UBS 2021, the bank provides a table of
Reconciliation of IFRS equity to Swiss SRB common equity tier 1
capital, select the items that adjust negatively the IFRS equity to
Common equity tier 1 capital. Prudential valuation adjustments (T)
Goodwill, net of tax (T) Minority interests (T) Deferred tax assets
recognized for tax loss carry-forwards (T)
SVB risk based on business model
Market risk (T) / liquidity risk (T) Fraud risk (F) credit risk (F)
Credit risk topics
What is(are) the solutions that banks can use to mitigate credit risk
associated with a loan? Collateral (T) guarantee (T) credit default swap
(T) loan covenant (T)
The following statements address the concept of credit risk and its
impacts on banks, select the correct one(s): Financial assets measured at
fair value are subject to CR (T) Financial assets at FVOCI are subject
to CR (T) Credit risk can also be hedged by derivative (T) Credit risk
refers to potential losses due to counterparty default or solvency
deterioration. Off-balance-sheet items are subject to credit risk. (T)
Basel rules and IFRS apply different rules on credit risk estimates (T)
CR refers to potential losses due to counterparty default or solvency
deterioration (T)
Lists 3 financial solutions that may enable the bank to reduce its
minimum require capital in relation to credit risk with immediate
effects: Securitization, Sale risky assets, Purchase CDS
The following statements address the concept of CR for a global bank
The banks Credit risk exposure determines its minimum regulatory
capital (T) The bank can apply internal based model to estimate credit
risk (T) Credit risk only subject to on balance sheet items (F) also off
BS Credit risk refers to potential losses due to banks solvency
deterioration (F)
Among the below accounts selects the ones subject to counterparty CR
Derivative assets (T) Investment securities (T) Letters of credit (F) 
contingent risk. Banks own debt (F)  bank default risk (T)
In the annual report UBS 2021, the bank provides a table of
Reconciliation of IFRS equity to Swiss SRB common equity tier 1
capital, select the items that may adjust negatively the IFRS equity to
Common equity tier 1 capital.
Deferred tax assets are recognized for tax loss carry-forward (T) PVA
(T), Goodwill (net of tax) (T) exp. Losses on advanced internal rating-
based portfolio less provisions (T)
A Swiss retail bank uses Swiss law as accounting reference, which of
the following comment(s) is(are) correct? The collaterals accepted by
the bank are recorded as financial assets. (T) In trading book, the bank
records the transactions ordered by customers. (F) The rise in interest
rate will increase the value of debt securities recorded in banking book.
(F) Change in interest rate risk will result in gains / losses on investment
portfolio, regardless of this investment portfolio is recorded in trading
book or banking book (F)
Regulatory capital subjects
Which solution(s) can improve banks’ regulatory capital ratio?
Securitization of loans with high-risk exposure (T) Increase capital by
issuing new shares (T) Stop guarantees provided to corporate customers
(T) Increase clients’ deposit. (F)
Which of the following comment(s) on the regulatory capital is(are)
correct?
Regulatory capital requirements differ by banks social and economic
impact (T) Capital Adequacy Ordinance (CAO) applies to Swiss banks
regulated by FINMA (T) Regulatory capital is based on fair value
accounting. (F) Off-balance sheet items are not relevant to the
regulatory capital adjustments. (F)
According to Basel III, select the regulatory ratio(s) which are risk
sensitive
CET1 capital ratio (T) Liquidity Coverage ratio (T) NSFR (T) LVG
ratio (F)
Suppose that in Q1-2020, a bank capital adequacy ratio fell below the
minimum regulatory requirements, which solution can improve the
regulatory capital ratio ? Stop the bank guarantees provided to corporate
customers (T) Hedge financial assets with market risk exposure (T)
Increase clients deposits (F) Secured borrowing from the central bank
(F)
Compared with industry firms, the banks’ financial statement(s) is(are)
characterized as: High leverage (T) Heavy financial assets (T) Limited
distinction between current / noncurrent accounts (T) Arbitrary
classification in cash flow statement (T) High liquidity (F) Low margin
(F)
According to Basel III and Capital Adequacy Ordinance (CAO), which
of following instrument(s) may contribute to loss absorption on a going-
concern basis: High contingent convertible securities (CoCos) (T) AT1
capital instruments (T) Client’s deposit (F) / Tier 2 capital instruments
(F)
The following statement(s) discuss the impact of credit risk on a bank's
reconciliation adjustment between IFRS 9 equity and the Basel III
regulatory capital, select the correct one(s): The Basel approach to
calculating expected losses is usually more conservative than the IFRS 9
approach. (T) If the regulatory ECL is larger than IFRS9 ECL, the
bank’s regulatory capital should subtract this difference from the IFRS
equity. (T) Comparing with standard approach, advanced internal-based
approach (A-IRB) is more compatible to IFRS 9 ECL in estimating
expected credit losses. (T) The Basel III A-IRB approach takes into
account expected losses resulting from expected default events
occurring within the next 12 months (T) The Basel III A-IRB approach
estimated the expected losses resulting from a default event over the
lifetime of the transaction. (F)
ECL (IFRS 9) Topics
A bank apples IFRS 9 the approach of Expected Credit Loss (ECL) for
loans, which of the following comment(s) is (are) correct with regard to
the impact of Covid-19 during 2020 to 2021? In Q1 2020, following the
Covid-19 related downturn, more loans are likely to be transferred from
Stage 1 to stage 2 or 3 (T) In 2021, as the economic development was
more positive than anticipated, following the covid 19 related downturn
in 2020, ECL allowance decreased and led to a positive impact on net
income (T) In Q1 2020, when a loan is classified at stage II, a full
lifetime is required (T) In 2021 ECL allowance is not necessary, if NPL
loan is reclassified as performing in Stage 1 (F)
A bank apples IFRS 9 the approach of Expected Credit Loss (ECL) for
loans, which of the following comment(s) is (are) correct with regard to
the impact of Covid-19 pandemic on bank’s credit risk during 2020 to
2022?
In 2022Q1, with the economy in full recovery, when a loan is classified
at Stage 1, a 12-month ECL is required. (T) In 2020, following the
economic downturn of COVID-19 crisis, the bank tends to transfer more
loans from Stage 1 to Stage 2. (T) In 2021, as the economic gradually
recovers from the COVID-19-related downturn, the movement on ECL
allowance was negative, which led to a positive impact on net income.
(T) In 2021, ECL allowance is zero if a loan is reclassified from non-
performing loan in Stage 2 to as performing loan in Stage 1. (F)
Under IFRS 9 which comment on Expected Credit loss model of loans
impairment are correct The application of ECL model affect banks
interest income (T) When a loan is classified at Stage II, a full lifetime
ECL is required (T) Loan loss provision is not necessary if the loan is
classified as performing (F) ECL model is based on historical statistics
(F)
Large banks often own many different types of derivatives, but among
which, only few derivatives are subject to hedge accounting. Which of
the following comment(s) about hedge accounting is(are) correct? There
should exist an economic relationship between the hedged item and the
hedging instrument (T) the hedging relationship should be used for the
bank’s risk management purpose (T) the changes in the FV of the
hedging instrument should equal to the changes in the FV of the hedged
item (F) eligible hedging instrument must be a derivative (F) (can be a
non-derivative)
Other topics
In Q1-N, Fortune bank issues a non-pre reimbursable bond with a
duration of 10 years, floating rate, payable quarterly. The banks applies
FV option for this own bond. After the bonds issuance, market interest
income increases and the other conditions remain unchanged, select the
correct comments on accounting for this bond Bank’s interest expense
increases (T) The fair value of this bond does not change (T) The fair
value of this bond decreases (F) Debt valuation adjustment is positive
(F)
In January 2021, required by ultra high net worth client, a trader of a
swiss private bank executed the order for this client to purchase 10
bitcoins paid from the clients’ deposit account in the bank. In Q2 2021,
the price of the bitcoin dropped about 60% compared with initial
purchase price, according too Circ. FINMA 2020/1, which of the
following comment on this transaction are correct? Impacts on banks
off-balance sheet items (T) The bank suffered an investment loss (F) No
impacts on banks balance sheet items (F) The bank suffered a higher
RWA (F)
Among the legal framework, select the items relevant to swiss banks
accounting & rep. Ordonnance sur les banques (T) FINMA circulaire
(T) CO (T) loi sur les banques (T)
Select the regulatory authority(ies) that regulate(s) and supervise(s)
banking and financial service firms in Switzerland: FINMA (T)
European central bank (F) Basel Committee on Banking Supervision
(BCBS) (F) / Swiss National Bank (F)
Market risk topics
The following statement address the implications of market risk and its
impacts on banks reporting: Market risk affects regulatory capital ratio
through RWA (correct with RWA also) (T) Items in banks trading book
are subject to market risk (T) PVA subjects to banks assets valued at
mark to market (MTM) (T) Commodity risk is one type of market risk
(T) Foreign exchange risk is one type of market risk (T) Market risk
might be correlated with credit risk (T) Interest rate risk (IRR) is one
type of market risk (T) Market risk is relevant to trading accounts and
investment accounts (T) Items in banks investment book are not subject
to MR (F) Financial assets at FVOCI are not subject to MR (F) When
interest rates increase, banks will benefit from the investment on fixed-
income securities. (F) Only the assets valued by marked-to-market are
subject to market risk (F) (level 2 also)
Which items are exposed to market risk Equity instruments in trading
book (T) Fix-floating SWAP (T) gold & commodities (T) Unsecured
fixed rate loans (F)
For a swiss commercial bank wich items are exposed to market risk ?
SARON-based mortgage (T) bank loans denominated in Euro (T) Credit
card loans (F) client’s portfolio book (F)
Which of the following comment(s) on banks’ risk weighted assets
is(are) correct? Leverage ratio is not risk sensitive  RWA is not used
to calculate bank Lvg ratio (T) RWA for operational risk is based on
income statement items. (T) RWA is based on risk exposure and risk
type. (T) RWA cover the risk exposure rising from banks off balance
sheet items (T) Items on banks income statement is irrelevant to
calculate RWA (F)
Which risks items affects banks RWA ? Interest rate risk (T) Operational
risk (T) Liquidity risk (F) Fraud risk (F)
Which of the following risk(s) can be mitigated by Asset-Liability
Management (ALM)? Interest risk (T) liquidity risk (T) currency risk
(T) Credit risk (F) compliance risk (F)
Which of the following comments on the general characteristics of bank
accounting is(are) correct? Banks are highly leveraged. (T) Banks have
lower range of assets than industry firms (T) The classification of banks
cash flow statement is arbitrage. (T) Interest income is the main revenue
of traditional retail banks. (T)
2020 mock
Which of the following comments on Risk Weighted Asset (RWA) is
(are) correct? RWA coefficients vary by different categories of financial
assets. (T) RWA is required by Basel rules, not IFRS. (T) Banks may
apply different approaches to calculate risk-weighted assets. (T) RWAs
are only determined by banks credit risk exposure (F) (also MR)
For a banking auditor, which of the following issues he(she) should
consider the potential accounting discretion when he (she) check an
investment security classified as financial assets at fair value through
other comprehensive income? assume that the bank applies IFRS but
does not select the Fair Value Option for financial assets and financial
liabilities.
Reclassification to financial assets at fair value through profit or loss (T)
Impairment of financial assets (T) Credit valuation adjustment (CVA)
(F) Loan loss provision (F)
For Swiss banks, which of the following comments on the regulation
and bank
reporting is(are) correct: FINMA has set higher capital ratios for some
Swiss banks than Basel requirement. (T) Swiss banks’ capital
requirement depends on size and classification (T) All Swiss banks
apply swiss bank rules according to Swiss Code of Obligation (F) All
Swiss banks apply the IFRS as reporting standards. (F)
Exercices
Prime Invest Bank (PIB) conducts tranched subprime mortgage
securitizations in which two tranches, senior and junior, are created. PIB
retains 10% the senior tranche and transfers the entire junior tranche to a
qualified special purpose entity (SPE). Both transferred tranches are
finally sold to a hedge fund firm. Refer to the following description of
the securitization above, click the accounting method that PIB should
apply for this securitization.
Scenario 1: PIB keeps continuous involvement in both tranches:
Secured borrowing
Scenario 1b: the securitized mortgages remain recognized on PIB
balance sheet as pledged assets: secured borrowing
Scenario 2: PIB holds the majority of SPE’s capital: consolidation with
SPE
Scenario 2b: SPE holds the control for the securitized mortgages of
both tranches : sales accounting
Beg End End N+1 End
N N N+2
Market value of 100 110 120 70
the security
Fair value of the 0 -10 -25 20
future contract
To lock the purchase price based on the current market price of 100, the
entity enters a 3 years future contract at 100 120-110 = 10 // 25-10 =
15 // 10/15 = 0.67
Calculating IFRS equity before adjustment (eligible CET1) 547 equity
before adj.
Goodwill, net of tax 15
Deferred tax asset, net of tax 63
Unrealized losses from cash flow hedge -102
DVA losses due to the own CR change in FV -36
liabilities
Prudent valuation adjustment (PVA) 230
547 – 15 – 63 + 102 + 36 – 230 = 377
XYZ Bank establishes a pass-through securitization with a special
purpose entity (SPE) for a portfolio of auto loans valued at $150
million, subject to the following condition:
Bank received $140 million in cash. The transferred senior tranche was
valued at $120 million. The retained subordinated tranche was valued at
$20 million. Retained servicing rights with an estimated fair value of $5
million Recourse obligation with an estimated fair value of $3 million.
The securitization qualifies for sales accounting. What is the impact of
this securitization on the bank's income? 150 + 3 (right side) /
140+20+5 (left side)  165 – 153 = 12 (gain on sale of 12 millinos)
Based on the below statistics, calculate the amount of VAR on a daily
basis, in million CHF: Size of the portfolio = CHF 1 million The
volatility in portfolio value per month = 5% (21 trading days per month)
The confidence level at 95% (The final amount rounds to 3 decimal
places) 5%/racine de 21 * 1.65 * 1mio =0.018 mio
Bank ABC applies Expected credit loss (ECL) under IFRS 9, see below
the movement of ECL during the year 2021. Total
Beginning balance ECL allowance 1’468
Movement of provision during year -203
ECL allowance due to changes in model inputs or 59
assumptions
ECL allowance due to model change -45
Remeasurements ECL due to stage transfers 40
Allowance change due to write-off uncollectible loans -155
Ending balance ECL allowance 1’164
Question: How much is the total impact on net income, due to the
movement of ECL allowance during year 2021? Please give the amount
with
signal (+ or -).: 203 -59 + 45 – 40 =+149
Assume initial allowance for loans to customer as of January 1 st: 15$,
during N, the bank recorded a charge off of 5$ on this loan type and
additional provision on loans losses of 8$ related to the newly issued
loans to customers
1. PLL to ALL 8 // 2. LCO to Loans 5 // ALL to LCO 5
January 1st a bank issued a corporate loan of 10 mio, with a fixed
interest rate of 2.5% annually, maturity in 3 years. To hedge, the
valuation fluctuation of this fixed rate loan, the bank engaged in a pay-
fixed (2.5%)/receive floating interest rate swap at the same date. Market
interest rate are N: 2% / N+1: 2%
N+2: 1.8%. how much is the faire value gain or loss of this Swap in N
10x((2%-2.5%)/1.02) = -0.04902 // 10x((2%-2.5%)/1.02^2)= -0.04803
 -0,04902 -0.04803 = 0.097
2181 – 2139 = 42

23 x √252 / √4 = 182.56