Learning Objectives: Identify and explain the components of expected loss and distinguish between expected loss and unexpected loss. Explain the requirements for estimating expected loss under IFRS 9. Describe a workout procedure for loss assets and compare the following two approaches used to manage loss assets: retaining loss assets and writing off loss assets. Explain the components of credit risk analysis. Explain the components of credit risk management capacity, and outline key questions that the board of directors of a bank should ask.
Questions:
24.5.1. Old Crow Bank approves a loan of $450,000 on January 1st for Lauren to purchase a home. The loan is classified under IFRS 9 as a performing loan and, therefore, uses a 12-month expected loss methodology. Lauren used the money to purchase a home on January 31st. If there is a 10% chance of default over the next 12 months and an 80% recovery rate (given default) over the same time period, what is Old Crow’s unexpected loss if Lauren defaults on the first payment on February 28th leading to a total loss of $34,000?
a. $9,000
b. $25,000
c. $34,000
d. $43,000
24.5.2. Converse and Old Crow Bank each make a loan of $1,000,000 at 4% interest to a technology startup, Janzee, in January of 2022. Unfortunately, Janzee makes only 4 payments. Janzee defaulted and became unlikely to repay its debt. Old Crow decides to retain the asset in hopes of recovering part of the loan one day while Converse decides to write off the lost asset. For the purposes of this question, all other items between the banks are the same.
Dan, a financial analyst, is evaluating both banks' financials. He wants to make the firm’s financial statements comparable. What would he need to change if he believes that the loan to Janzee will never be recovered?
a. Reduce Old Crow’s asset values only.
b. Increase Old Crow’s loan loss reserves only.
c. Reduce Old Crow’s asset values and its loan loss reserves.
d. Reduce Old Crow’s asset values and increase its loan loss reserves.
24.5.3. The board of directors for Old Crow, a regional bank, meets once a quarter. John Jones is the secretary and recorded the details of the last meeting. Key credit risk items discussed at last quarter's meeting include:
a. The board should have included a discussion of loan pricing in their review of new loan offerings.
b. The board should not have included a discussion on staffing while discussing credit risk.
c. The board should have discussed loan pricing in its review of new loan offerings and reviewed the accuracy of internal ratings models.
d. The board should not have discussed staffing while discussing credit risk but should have discussed the accuracy of internal ratings models.
Answers here:
Questions:
24.5.1. Old Crow Bank approves a loan of $450,000 on January 1st for Lauren to purchase a home. The loan is classified under IFRS 9 as a performing loan and, therefore, uses a 12-month expected loss methodology. Lauren used the money to purchase a home on January 31st. If there is a 10% chance of default over the next 12 months and an 80% recovery rate (given default) over the same time period, what is Old Crow’s unexpected loss if Lauren defaults on the first payment on February 28th leading to a total loss of $34,000?
a. $9,000
b. $25,000
c. $34,000
d. $43,000
24.5.2. Converse and Old Crow Bank each make a loan of $1,000,000 at 4% interest to a technology startup, Janzee, in January of 2022. Unfortunately, Janzee makes only 4 payments. Janzee defaulted and became unlikely to repay its debt. Old Crow decides to retain the asset in hopes of recovering part of the loan one day while Converse decides to write off the lost asset. For the purposes of this question, all other items between the banks are the same.
Dan, a financial analyst, is evaluating both banks' financials. He wants to make the firm’s financial statements comparable. What would he need to change if he believes that the loan to Janzee will never be recovered?
a. Reduce Old Crow’s asset values only.
b. Increase Old Crow’s loan loss reserves only.
c. Reduce Old Crow’s asset values and its loan loss reserves.
d. Reduce Old Crow’s asset values and increase its loan loss reserves.
24.5.3. The board of directors for Old Crow, a regional bank, meets once a quarter. John Jones is the secretary and recorded the details of the last meeting. Key credit risk items discussed at last quarter's meeting include:
- The board discussed new loan offerings and staffing of the credit management team.
- The board discussed risk measures, including variance and VAR levels of loans, and whether the levels of risk taken are indicative of risks being taken by the bank.
- Board members then reviewed the accuracy of the probability of default, loss given default, and exposure at default assumptions, along with the accuracy of external ratings models.
- After reviewing external ratings model, the board of directors reviewed the security of income from its loan portfolio.
- Board members then reviewed stress tests of loan portfolios and discussed the process of working out problematic loans.
- The board then looked at a series of reports that discussed concentration risk from numerous perspectives.
a. The board should have included a discussion of loan pricing in their review of new loan offerings.
b. The board should not have included a discussion on staffing while discussing credit risk.
c. The board should have discussed loan pricing in its review of new loan offerings and reviewed the accuracy of internal ratings models.
d. The board should not have discussed staffing while discussing credit risk but should have discussed the accuracy of internal ratings models.
Answers here:
