CAIIB ABM Module C UNIT 23 MCQ – Risk Management and Credit Rating

CAIIB ABM Module C UNIT 23 MCQ – Risk Management and Credit Rating.

Question 1: The business of banking faces which broad categories of risks?

A. Strategic, Financial, and Compliance Risks
B. Operational, Market, and Credit Risks
C. Liquidity, Solvency, and Interest Rate Risks
D. Technological, Legal, and Reputational Risks

Show Explanation

Correct Answer: B. Operational, Market, and Credit Risks.

Question 2: What is an example of an Operational Risk for a bank?

A. Losses due to fluctuations in the exchange rate
B. Losses due to non-payment of a loan by a borrower
C. Losses due to frauds
D. Losses due to adverse changes in government policies

Show Explanation

Correct Answer: C. Losses due to frauds. Operational Risks include losses due to internal or external fraud.

Question 3: Market Risks for banks arise from what?

A. Failure of internal processes
B. Non-payment of dues by borrowers
C. Adverse market movements of interest rates
D. Errors in loan documentation

Show Explanation

Correct Answer: C. Adverse market movements of interest rates. Market Risks are caused by uncontrollable market forces.

Question 4: In fund-based credit facilities, what does credit risk primarily involve?

A. The risk of operational losses
B. The risk of adverse market movements
C. The risk of non-payment of principal and interest by the borrower
D. The risk of changes in government regulations

Show Explanation

Correct Answer: C. The risk of non-payment of principal and interest by the borrower. Credit risk in lending is the risk of default.

Question 5: In a non-fund-based limit, when does credit risk arise?

A. When the bank’s operational processes fail
B. When the borrower does not reimburse the bank after invocation of a guarantee
C. When market interest rates fluctuate
D. When government policies change

Show Explanation

Correct Answer: B. When the borrower does not reimburse the bank after invocation of a guarantee. This is a credit risk in non-fund facilities.

Question 6: Credit risks are related to the borrower’s…

A. unwillingness or inability to meet financial obligations.
B. operational inefficiencies.
C. response to market fluctuations.
D. compliance with regulatory norms.

Show Explanation

Correct Answer: A. unwillingness or inability to meet financial obligations. Credit risks arise from the borrower’s potential default.

Question 7: Which of the following is an External Factor that can affect credit risk?

A. Faulty loan and repayment structuring
B. Government policies
C. Low quality of credit appraisal
D. Excessive lending to cyclical industries

Show Explanation

Correct Answer: B. Government policies. External factors are those outside the bank’s control.

Question 8: How do external factors primarily affect a bank’s credit portfolio?

A. By directly affecting the bank’s profitability
B. By impairing the quality of the customers’ businesses
C. By increasing the bank’s operational costs
D. By influencing the bank’s internal policies

Show Explanation

Correct Answer: B. By impairing the quality of the customers’ businesses. External factors affect the borrower’s ability to pay.

Question 9: Which of the following is an Internal Factor that can contribute to credit risk?

A. Political risks
B. Exchange rate fluctuations
C. Faulty loan and repayment structuring
D. Protectionist policies of other countries

Show Explanation

Correct Answer: C. Faulty loan and repayment structuring. Internal factors are within the bank’s control.

Question 10: Overexposure of credit refers to…

A. lending to multiple borrowers.
B. lending to a particular segment or region.
C. lending at high interest rates.
D. lending with insufficient collateral.

Show Explanation

Correct Answer: B. lending to a particular segment or region. Overexposure increases concentration risk.

Question 11: What does ‘excessive lending to cyclical industries’ indicate?

A. A well-diversified loan portfolio
B. Increased credit risk due to industry volatility
C. A conservative lending strategy
D. A focus on high-growth sectors

Show Explanation

Correct Answer: B. Increased credit risk due to industry volatility. Cyclical industries are prone to fluctuations.

Question 12: Ignoring the purpose of a loan can lead to…

A. better loan monitoring.
B. reduced credit risk.
C. higher chances of default.
D. improved customer relations.

Show Explanation

Correct Answer: C. higher chances of default. Understanding the loan’s purpose is crucial for risk assessment.

Question 13: Deficiencies in loan policy refer to…

A. robust credit appraisal.
B. well-defined lending limits.
C. inadequate guidelines for lending.
D. efficient recovery processes.

Show Explanation

Correct Answer: C. inadequate guidelines for lending. Deficiencies can increase credit risk.

Question 14: Low quality of credit appraisal means…

A. thorough evaluation of loan proposals.
B. insufficient assessment of borrower’s creditworthiness.
C. regular monitoring of loan accounts.
D. effective recovery mechanisms.

Show Explanation

Correct Answer: B. insufficient assessment of borrower’s creditworthiness. It leads to higher risk.

Question 15: Lack of an efficient recovery machinery results in…

A. prompt loan recoveries.
B. lower non-performing assets.
C. increased credit losses.
D. better credit monitoring.

Show Explanation

Correct Answer: C. increased credit losses. Inefficient recovery increases the bank’s losses.

Question 16: What is the primary objective of credit risk management?

A. To maximise the volume of loans
B. To minimise operational costs
C. To limit risk within acceptable levels and maximise risk-adjusted return
D. To increase the bank’s market share

Show Explanation

Correct Answer: C. To limit risk within acceptable levels and maximise risk-adjusted return. This is the core goal of credit risk management.

Question 17: At the macro level, how are risks to the overall credit portfolio mitigated?

A. By focusing on individual loan appraisals
B. By fixing internal limits for aggregate commitments to specific sectors
C. By obtaining collateral security for each loan
D. By using credit derivatives

Show Explanation

Correct Answer: B. By fixing internal limits for aggregate commitments to specific sectors. This ensures diversification.

Question 18: What does a periodic review of loan policies involve?

A. Appraisal of individual loan proposals
B. Reviewing exposure norms to single and group borrowers
C. Obtaining personal guarantees from borrowers
D. Using credit default swaps

Show Explanation

Correct Answer: B. Reviewing exposure norms to single and group borrowers. This is a macro-level risk mitigation activity.

Question 19: Why do banks classify their credit portfolio?

A. To increase loan disbursements
B. To avoid credit losses
C. To assess provisioning requirements
D. To promote competition

Show Explanation

Correct Answer: C. To assess provisioning requirements. Classification helps in managing potential losses.

Question 20: What is the purpose of stress resolution policies?

A. To avoid lending to stressed assets
B. To recover the maximum possible from a difficult situation
C. To increase interest rates on risky loans
D. To depend entirely on collateral security

Show Explanation

Correct Answer: B. To recover the maximum possible from a difficult situation. Stress resolution aims to manage bad loans.

Question 21: Which of the following is a micro-level step in credit risk mitigation?

A. Fixing internal limits for specific sectors
B. Reviewing loan policies
C. Improving appraisal standards
D. Reviewing the credit portfolio

Show Explanation

Correct Answer: C. Improving appraisal standards. This focuses on individual loan assessments.

Question 22: What is the purpose of obtaining collateral security?

A. To increase the interest rate on the loan
B. To transfer the credit risk
C. To provide a secondary source of repayment
D. To simplify the loan documentation process

Show Explanation

Correct Answer: C. To provide a secondary source of repayment. Collateral reduces the bank’s potential loss.

Question 23: What is an ‘escrow mechanism’?

A. A method of credit rating
B. A way to transfer credit risk
C. An arrangement where funds are held by a third party until certain conditions are met
D. A type of credit derivative

Show Explanation

Correct Answer: C. An arrangement where funds are held by a third party until certain conditions are met. It provides security.

Question 24: How do credit ratings and credit scoring contribute to credit risk management?

A. By increasing the volume of loans
B. By helping in appraisal, sanctioning, and monitoring of loans
C. By eliminating the need for collateral security
D. By reducing interest rates on loans

Show Explanation

Correct Answer: B. By helping in appraisal, sanctioning, and monitoring of loans. They aid in assessing and managing risk.

Question 25: What is consortium banking?

A. Lending to only a select group of borrowers
B. Lending by a group of banks to a single borrower
C. Lending to small businesses
D. Lending without collateral

Show Explanation

Correct Answer: B. Lending by a group of banks to a single borrower. It helps in risk dispersion.

Question 26: What are credit derivatives used for?

A. To increase the bank’s profits
B. To hedge credit risks
C. To attract more borrowers
D. To simplify loan documentation

Show Explanation

Correct Answer: B. To hedge credit risks. They help in transferring risk.

Question 27: How do credit derivatives hedge credit risk?

A. By transferring the asset
B. By insuring against potential losses
C. By increasing the interest rate
D. By avoiding lending to risky borrowers

Show Explanation

Correct Answer: B. By insuring against potential losses. They act like insurance for credit risk.

Question 28: What is a drawback of using credit derivatives for hedging?

A. They increase the return from the asset
B. The return from the asset may be less if the anticipated risk does not materialise
C. They simplify the process of credit risk management
D. They eliminate the need for collateral security

Show Explanation

Correct Answer: B. The return from the asset may be less if the anticipated risk does not materialise. Hedging comes at a cost.

Question 29: Which of the following is an example of a simple technique for transferring credit risk?

A. Credit Default Swaps
B. Collateralised Debt Obligations
C. Financial guarantees
D. Credit Linked Notes

Show Explanation

Correct Answer: C. Financial guarantees. These have been used in India for a long time.

Question 30: Which of the following is a recent innovative instrument in credit risk transfer?

A. Credit insurance
B. Credit Default Swaps
C. Collateral security
D. Financial guarantees

Show Explanation

Correct Answer: B. Credit Default Swaps. These are newer instruments for hedging credit risk.

Question 31: What is a Credit Default Swap (CDS)?

A. A type of loan
B. A contract that provides protection against credit default
C. A type of collateral
D. A method of credit rating

Show Explanation

Correct Answer: B. A contract that provides protection against credit default. It’s a hedging instrument.

Question 32: In a Credit Default Swap, who pays the premium?

A. The borrower
B. The risk seller (lending bank)
C. The protection seller
D. The bond issuer

Show Explanation

Correct Answer: B. The risk seller (lending bank). They pay for the protection.

Question 33: What is the ‘reference entity’ in a Credit Default Swap?

A. The lending bank
B. The protection seller
C. The bond issuer on whom the protection is offered
D. The protection buyer

Show Explanation

Correct Answer: C. The bond issuer on whom the protection is offered. It’s the entity whose credit is being protected.

Question 34: What happens when the risk event materialises in a Credit Default Swap?

A. The protection seller pays the principal and interest to the buyer.
B. The protection buyer hands over the debt instrument to the protection seller.
C. The bond issuer declares bankruptcy.
D. The lending bank writes off the loan.

Show Explanation

Correct Answer: B. The protection buyer hands over the debt instrument to the protection seller. This is how the swap is settled.

Question 35: Credit Default Swaps in India are based on the standards of which organisation?

A. RBI
B. SEBI
C. ISDA (International Swaps and Derivatives Association)
D. World Bank

Show Explanation

Correct Answer: C. ISDA (International Swaps and Derivatives Association). They provide standardisation.

Question 36: Which of the following is a ‘credit event’ as defined by ISDA?

A. Increase in interest rates
B. Bankruptcy
C. Political instability
D. Market volatility

Show Explanation

Correct Answer: B. Bankruptcy. Credit events trigger the CDS payout.

Question 37: What is a Credit Linked Note (CLN)?

A. A type of loan
B. A type of bond
C. A note linked to an underlying credit that provides risk protection
D. A type of credit rating

Show Explanation

Correct Answer: C. A note linked to an underlying credit that provides risk protection. It’s another hedging instrument.

Question 38: In a Credit Linked Note, who typically purchases the notes?

A. The lending bank
B. The borrowing company
C. General investors
D. The central bank

Show Explanation

Correct Answer: C. General investors. They provide the funds for the SPV.

Question 39: What does the Special Purpose Vehicle (SPV) do with the money received from investors in a CLN?

A. Lends it to high-risk borrowers
B. Buys high quality securities
C. Invests in the stock market
D. Holds it in a current account

Show Explanation

Correct Answer: B. Buys high quality securities. These are used to pay back investors or cover losses.

Question 40: What happens to the securities purchased by the SPV on maturity of the underlying credit?

A. They are given to the borrower.
B. They are sold, and the money is returned to the investors.
C. They are used to pay the lending bank.
D. They are held by the SPV indefinitely.

Show Explanation

Correct Answer: B. They are sold, and the money is returned to the investors. This is the typical maturity process.

Question 41: In case of default in the underlying credit, what happens to the securities held by the SPV?

A. They are given to the investors.
B. They are used to pay the risk seller.
C. They are sold in the market.
D. They are held by the SPV.

Show Explanation

Correct Answer: B. They are used to pay the risk seller. This provides the risk protection.

Question 42: What is the RBI’s stance on banks using derivatives to hedge credit risk?

A. RBI encourages it to stabilise the financial market.
B. RBI has no specific view.
C. RBI is apprehensive when banks sell credit protection.
D. RBI mandates it for all banks.

Show Explanation

Correct Answer: C. RBI is apprehensive when banks sell credit protection. It can lead to complex and large liabilities.

Question 43: Why is RBI cautious about the growth of credit derivatives in the Indian financial market?

A. Because they are too simple to understand.
B. Because they can become very complex and create large, unexpected liabilities.
C. Because they reduce the profitability of banks.
D. Because they increase competition in the banking sector.

Show Explanation

Correct Answer: B. Because they can become very complex and create large, unexpected liabilities. Complexity is a major concern.

Question 44: What does RBI advise lenders regarding credit appraisal?

A. To solely depend on credit appraisal reports from the borrowing entity’s consultants.
B. To carry out their own independent and objective credit appraisal.
C. To outsource credit appraisal to external consultants.
D. To avoid credit appraisal for infrastructure projects.

Show Explanation

Correct Answer: B. To carry out their own independent and objective credit appraisal. This ensures due diligence.

Question 45: What kind of analysis does RBI recommend for infrastructure projects?

A. Cost-benefit analysis
B. Sensitivity tests/scenario analysis
C. SWOT analysis
D. Ratio analysis

Show Explanation

Correct Answer: B. Sensitivity tests/scenario analysis. This helps in assessing potential risks like delays and cost overruns.

Question 46: What should lenders ascertain about the equity capital brought in by promoters?

A. The amount of equity capital only
B. The source and quality of equity capital
C. The debt-to-equity ratio
D. The market capitalisation of the company

Show Explanation

Correct Answer: B. The source and quality of equity capital. This helps in assessing the financial strength of the project.

Question 47: What is ‘multiple leveraging’?

A. Borrowing from multiple banks
B. Investing in multiple projects
C. Infusion of parent company’s debt as equity in a subsidiary
D. Raising equity from multiple sources

Show Explanation

Correct Answer: C. Infusion of parent company’s debt as equity in a subsidiary. It can distort financial ratios.

Question 48: Why is multiple leveraging a concern for lenders?

A. It increases the profitability of the borrowing company.
B. It camouflages financial ratios like the Debt/Equity ratio.
C. It simplifies the credit appraisal process.
D. It reduces the risk of adverse selection of borrowers.

Show Explanation

Correct Answer: B. It camouflages financial ratios like the Debt/Equity ratio.

Question 49: According to the Companies Act 2013, what is mandatory for every director?

A. To have a bank account
B. To have a Director Identification Number (DIN)
C. To be a shareholder in the company
D. To have a credit rating

Show Explanation

Correct Answer: B. To have a Director Identification Number (DIN). This is required by the Act.

Question 50: What is the purpose of including the Director Identification Number (DIN) in data submitted to the Reserve Bank of India/Credit Information Companies?

A. To simplify the loan application process
B. To ensure directors are correctly identified and not wrongfully denied credit
C. To track the financial transactions of directors
D. To improve the credit rating of companies

Show Explanation

Correct Answer: B. To ensure directors are correctly identified and not wrongfully denied credit. This prevents errors due to similar names.

Question 51: What should banks do in case of any doubt arising from identical names of directors?

A. Seek a declaration from the borrowing company
B. Rely on the company’s auditors for confirmation
C. Use independent sources for confirmation of the identity of directors
D. Reject the loan application

Show Explanation

Correct Answer: C. Use independent sources for confirmation of the identity of directors. This ensures accuracy.

Question 52: What do RBI guidelines say about monitoring the end-use of funds?

A. Lenders should solely rely on the borrower’s auditors’ certification.
B. Lenders can award a separate mandate to the borrower’s auditors for specific certification.
C. Lenders should avoid any certification of end-use of funds.
D. Lenders should depend on internal audits only.

Show Explanation

Correct Answer: B. Lenders can award a separate mandate to the borrower’s auditors for specific certification. This helps in monitoring fund usage.

Question 53: What is RBI’s advice to banks regarding auditors for certification of end-use of funds?

A. Banks must always engage their own auditors and not rely on borrower’s auditors.
B. Banks should only rely on certification given by borrower’s auditors.
C. Banks could consider engaging their own auditors for specific certification.
D. Banks should avoid any audit of end-use of funds.

Show Explanation

Correct Answer: C. Banks could consider engaging their own auditors for specific certification. This provides an independent check.

Question 54: What is the role of the Board of Directors of banks in credit risk management?

A. To focus on increasing loan disbursements
B. To avoid any involvement in asset quality
C. To take steps to arrest deteriorating asset quality and improve the credit risk management system
D. To delegate all credit-related decisions to the management

Show Explanation

Correct Answer: C. To take steps to arrest deteriorating asset quality and improve the credit risk management system. The Board plays a crucial oversight role.

Question 55: What is the purpose of the Central Repository of Information on Large Credits (CRILC)?

A. To provide credit ratings to borrowers
B. To collect, store, and disseminate credit data to lenders
C. To regulate the interest rates charged by banks
D. To provide insurance for credit defaults

Show Explanation

Correct Answer: B. To collect, store, and disseminate credit data to lenders. CRILC facilitates information sharing.

Question 56: What information do banks need to report to CRILC?

A. Information on all borrowers, regardless of the loan amount
B. Credit information on borrowers with aggregate exposure of ₹5 crores and above
C. Information on interbank exposures
D. Information on crop loans

Show Explanation

Correct Answer: B. Credit information on borrowers with aggregate exposure of ₹5 crores and above. There are specific reporting thresholds.

Question 57: Are crop loans required to be reported to CRILC?

A. Yes, all crop loans must be reported.
B. No, crop loans are exempted from reporting to CRILC.
C. Only crop loans above ₹5 crores need to be reporteD.
D. Crop loans are reported only if they are non-performing assets.

Show Explanation

Correct Answer: B. No, crop loans are exempted from reporting to CRILC. However, other agriculture loans may need to be reported.

Question 58: Do banks need to report their interbank exposures to CRILC?

A. Yes, all interbank exposures must be reported.
B. No, interbank exposures are not reported to CRILC.
C. Only interbank exposures above ₹5 crores need to be reporteD.
D. Interbank exposures are reported only if they are to private banks.

Show Explanation

Correct Answer: B. No, interbank exposures are not reported to CRILC. This exemption applies to exposures to certain institutions.

Question 59: What is the reporting requirement for outstanding current account balances to RBI?

A. All current account balances must be reported.
B. Only current account balances of ₹5 crores and above must be reported.
C. Outstanding current account balances of ₹1 crore and above must be reporteD.
D. Only overdrawn current account balances must be reported.

Show Explanation

Correct Answer: C. Outstanding current account balances of ₹1 crore and above must be reported. RBI has specific reporting rules for these balances.

Question 60: Why was the credit information system introduced?

A. To increase competition among banks
B. To provide loans at lower interest rates
C. To alert banks against borrowers who have defaulted with other institutions
D. To reduce the profitability of banks

Show Explanation

Correct Answer: C. To alert banks against borrowers who have defaulted with other institutions. This helps in preventing further defaults.

Question 1: The business of banking faces which broad categories of risks?

Question 2: What is an example of an Operational Risk for a bank?

Question 3: Market Risks for banks arise from what?

Question 4: In fund-based credit facilities, what does credit risk primarily involve?

Question 5: In a non-fund-based limit, when does credit risk arise?

Question 6: Credit risks are related to the borrower’s…

Question 7: Which of the following is an External Factor that can affect credit risk?

Question 8: How do external factors primarily affect a bank’s credit portfolio?

Question 9: Which of the following is an Internal Factor that can contribute to credit risk?

Question 10: Overexposure of credit refers to…

Question 11: What does ‘excessive lending to cyclical industries’ indicate?

Question 12: Ignoring the purpose of a loan can lead to…

Question 13: Deficiencies in loan policy refer to…

Question 14: Low quality of credit appraisal means…

Question 15: Lack of an efficient recovery machinery results in…

Question 16: What is the primary objective of credit risk management?

Question 17: At the macro level, how are risks to the overall credit portfolio mitigated?

Question 18: What does a periodic review of loan policies involve?

Question 19: Why do banks classify their credit portfolio?

Question 20: What is the purpose of stress resolution policies?

Question 21: Which of the following is a micro-level step in credit risk mitigation?

Question 22: What is the purpose of obtaining collateral security?

Question 23: What is an ‘escrow mechanism’?

Question 24: How do credit ratings and credit scoring contribute to credit risk management?

Question 25: What is consortium banking?

Question 26: What are credit derivatives used for?

Question 27: How do credit derivatives hedge credit risk?

Question 28: What is a drawback of using credit derivatives for hedging?

Question 29: Which of the following is an example of a simple technique for transferring credit risk?

Question 30: Which of the following is a recent innovative instrument in credit risk transfer?

Question 31: What is a Credit Default Swap (CDS)?

Question 32: In a Credit Default Swap, who pays the premium?

Question 33: What is the ‘reference entity’ in a Credit Default Swap?

Question 34: What happens when the risk event materialises in a Credit Default Swap?

Question 35: Credit Default Swaps in India are based on the standards of which organisation?

Question 36: Which of the following is a ‘credit event’ as defined by ISDA?

Question 37: What is a Credit Linked Note (CLN)?

Question 38: In a Credit Linked Note, who typically purchases the notes?

Question 39: What does the Special Purpose Vehicle (SPV) do with the money received from investors in a CLN?

Question 40: What happens to the securities purchased by the SPV on maturity of the underlying credit?

Question 41: In case of default in the underlying credit, what happens to the securities held by the SPV?

Question 42: What is the RBI’s stance on banks using derivatives to hedge credit risk?

Question 43: Why is RBI cautious about the growth of credit derivatives in the Indian financial market?

Question 44: What does RBI advise lenders regarding credit appraisal?

Question 45: What kind of analysis does RBI recommend for infrastructure projects?

Question 46: What should lenders ascertain about the equity capital brought in by promoters?

Question 47: What is ‘multiple leveraging’?

Question 48: Why is multiple leveraging a concern for lenders?

Question 49: According to the Companies Act 2013, what is mandatory for every director?

Question 50: What is the purpose of including the Director Identification Number (DIN) in data submitted to the Reserve Bank of India/Credit Information Companies?

Question 51: What should banks do in case of any doubt arising from identical names of directors?

Question 52: What do RBI guidelines say about monitoring the end-use of funds?

Question 53: What is RBI’s advice to banks regarding auditors for certification of end-use of funds?

Question 54: What is the role of the Board of Directors of banks in credit risk management?

Question 55: What is the purpose of the Central Repository of Information on Large Credits (CRILC)?

Question 56: What information do banks need to report to CRILC?

Question 57: Are crop loans required to be reported to CRILC?

Question 58: Do banks need to report their interbank exposures to CRILC?

Question 59: What is the reporting requirement for outstanding current account balances to RBI?

Question 60: Why was the credit information system introduced?

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