Tutorial 7a Slide 9 & 10 regarding COF

[ceciliaclm]

Hi David,

Just wanna ask,for slide 9 to calculate the cost of fund,we do need to subtract economic capital from the loan portfolio in order to calculate COF.But why is that in slide 10,we just directly multiply the interest on deposits to the total deposits without subtracting economic capital?

Thanks!

Regards,
Ceci

 

[David Harper CFA FRM]

Hi Ceci,

It's a good observation: page 9 reflects the first print version of Crouhy and page 10 reflects the most recent (revised). Note the "Crouhy v2" on page10. Several forum threads have debated the difference; e.g., http://forum.bionicturtle.com/viewthread/515/

In the tutorial, at end of 10, I think i mentioned the balance sheet implications: in my view, it really comes down to whether you think a $1 BB balance sheet is appropriate here (page 9 implies $1 BB) or $1.075 ($ 1 BB).

Although I submitted the original (first print error) to Crouhy that (I think) prompted the revision, my personal view is that either is okay, as both meet "ratio consistency." There are some good arguments for either version, IMO. But nobody seems to be able to make a decisive argument for a "correct" version, except, it's worth nothing Crouhy settled on v2, for what it's worth.

The reason I kept the p9 version is simply that one of the GARP practice (prior exam) questions used this approach (i.e., deposits = loans - EC). Otherwise, I would have just used the approach in p10 and avoided potential confusion (but most folks frankly don't notice, like you did)

...but, aside from the interesting theoretical issue (which balance sheet?), for exam purposes, don't worry because the question should certainly tell you how to size the deposits (to determine cost of funds). This issue has long been on my submission list to GARP .... Thanks! David