CAIIB BFM Module B – Unit 12 MCQ – Risks in Banking Business

Correct Answer: C. Mergers & Acquisitions are listed as an activity within the Corporate Finance business line.

Correct Answer: B. Trading and Sales includes Market Making, Proprietary Positions, and Treasury.

Correct Answer: D. Retail Banking focuses on services for individual customers, including lending, deposits, and cards.

Correct Answer: C. Commercial Banking deals with financing for businesses, including Project Finance, Real Estate Finance, and Trade Finance.

Correct Answer: B. Payments and Settlement specifically handles the processes of transferring funds and clearing transactions.

Correct Answer: C. Agency Services include acting on behalf of clients, such as providing Custody and Corporate Trust services.

Correct Answer: A. Asset Management involves managing client funds, described as Discretionary/Non-Discretionary Fund Management.

Correct Answer: D. Retail Brokerage provides services like Execution (placing trades) and Full Service (advice and execution) for individual investors.

Correct Answer: C. These are listed as examples of Standard Lending Products offered by banks.

Correct Answer: B. The syllabus explicitly mentions Bill purchase and Cash credit as examples of Lines of credit.

Correct Answer: C. These loan types are specifically mentioned as examples of Retail Segment Loans.

Correct Answer: C. Guarantees and Letters of Credit are listed as examples of Off-Balance Sheet Transactions.

Correct Answer: B. These are financial instruments traded in the market and are classified as Market Products.

Correct Answer: C. The syllabus lists Swaps and Options as types of Derivatives.

Correct Answer: D. Operational Risk is defined as the risk arising from inadequate or failed internal processes, people, and systems or from external events.

Correct Answer: C. Effective operational risk management requires anticipating potential problems before they occur.

Correct Answer: C. Training is highlighted as a crucial element in managing operational risk.

Correct Answer: C. Credit Risk is specifically defined as the risk of a borrower failing to meet their contractual obligations.

Correct Answer: B. Market Risk is defined as the risk of losses caused by movements in market prices.

Correct Answer: A. Liquidity Risk is the risk that a bank cannot meet its obligations as they become due.

Correct Answer: C. The three broad categories mentioned for risk management are The Banking Book, The Trading Portfolio, and Off-Balance Sheet Exposures.

Correct Answer: C. The Banking Book is defined as primarily including loans and deposits which are typically held to maturity.

Correct Answer: C. Liquidity Risk in the Banking Book specifically arises from differences in the timing of cash inflows (from assets maturing) and outflows (to meet liabilities).

Correct Answer: C. Interest Rate Risk here refers to how changes in interest rates affect the difference between the interest earned on assets and interest paid on liabilities (net interest margin).

Correct Answer: C. The Trading Book includes assets like securities, forex, commodities, and derivatives that are held with the intention of trading.

Correct Answer: C. Off-Balance Sheet Exposures represent potential obligations or assets that depend on a future event occurring.

Correct Answer: C. The Banking Book holds assets/liabilities typically until maturity, whereas the Trading Book involves active trading and short holding periods.

Correct Answer: D. The Banking Book uses accrual accounting, while the Trading Book uses Mark-to-Market (MTM) accounting.

Correct Answer: C. The Banking Book is valued based on its book value (using accrual), while the Trading Book is valued at current market prices (MTM).

Correct Answer: C. Capital for the Banking Book is mainly driven by credit risk, while capital for the Trading Book is mainly driven by market risk.

Correct Answer: B. The main risks highlighted for the Banking Book are Liquidity Risk, Interest Rate Risk, Credit/Default Risk, and Operational Risk.

Correct Answer: A. The main risks highlighted for the Trading Book are Market Risk, Liquidation Risk, Credit/Default Risk, and Operational Risk.

Correct Answer: B. Liquidity Risk is defined as the inability to obtain necessary funds to meet cash flow obligations without incurring excessive costs.

Correct Answer: D. These are listed as the different types of Liquidity Risk.

Correct Answer: B. Funding Risk deals with the challenge of replacing funds when depositors withdraw money or don’t renew their deposits.

Correct Answer: C. Time Risk arises when expected incoming cash flows do not arrive as scheduled.

Correct Answer: C. Call Risk refers to the crystallization (becoming real) of contingent liabilities, often due to events like customer defaults.

Correct Answer: C. Liquidity risk can lead to higher costs to obtain funds, inability to meet obligations (funding gaps), and in severe cases, default.

Correct Answer: C. This situation creates Funding Risk because the short-term deposits might be withdrawn before the long-term loans mature or generate returns.

Correct Answer: B. IRR is defined as the risk to a bank’s earnings or value due to unfavorable changes in interest rates.

Correct Answer: B. IRR affects the bank’s profitability (NII, NIM) and also the overall economic value, represented by the Market Value of Equity.

Correct Answer: C. Market Risk is defined as the risk of losses in the trading portfolio due to unfavorable movements in market factors like prices, rates, etc.

Correct Answer: D. Market Risk is often called Price Risk because it relates to losses caused by changes in market prices.

Correct Answer: C. These are listed as components contributing to the overall Market Risk of the trading portfolio.

Correct Answer: A. Forex Risk specifically relates to potential losses arising from changes in the value of one currency relative to another.

Correct Answer: C. Market Liquidity Risk is about the inability to buy or sell large quantities of an asset in the market without substantially impacting its price.

Correct Answer: D. This is a direct example of Forex Risk, where changes in exchange rates cause losses on foreign currency holdings.

Correct Answer: B. Default or Credit Risk is fundamentally the risk that someone who owes the bank money (borrower or counterparty) will not pay it back as agreed.

Correct Answer: C. These are listed as the two main types of Default or Credit Risk.

Correct Answer: A. Counterparty Risk is the specific risk that the other party in a trade or financial transaction will not fulfill their side of the agreement.

Correct Answer: C. Country Risk involves non-performance specifically due to factors related to the sovereign country, such as political instability or legal/regulatory constraints.

Correct Answer: C. These are listed as specific types of Interest Rate Risk.

Correct Answer: A. Gap Risk arises from differences in the timing of when asset and liability interest rates can be changed or when they mature.

Correct Answer: C. This is a classic example of Gap/Mismatch Risk because the asset’s rate is fixed for longer than the liability’s rate.

Correct Answer: B. Basis Risk occurs because the ‘basis’ or spread between different interest rate benchmarks does not remain constant.

Correct Answer: B. This illustrates Basis Risk, as the two different benchmarks moved by different magnitudes, affecting the bank’s margin.

Correct Answer: B. Yield Curve Risk arises when interest rates for different maturities change differently (e.g., short-term rates rise while long-term rates fall), affecting positions sensitive to the yield curve’s shape.

Correct Answer: C. This is an example of Yield Curve Risk because the profitability depends on how the relationship between 1-year rates and 3-month rates changes over time.

Correct Answer: C. Many financial products have ’embedded options’ (like the option to prepay a loan or withdraw a deposit early), and the exercise of these options due to rate changes causes Embedded Option Risk.

Correct Answer: D. The borrowers are exercising their implicit option to prepay, which is a form of Embedded Option Risk for the bank.

Correct Answer: B. Reinvestment Risk concerns the possibility that when cash flows are received (e.g., from maturing investments), the available interest rates for reinvesting that money might be lower than expected.

Correct Answer: B. While related to Embedded Option risk for the customer’s action, the syllabus example links a depositor shifting funds for higher rates directly to Reinvestment Risk for the bank (implying the bank now has less to reinvest or needs to replace funds at a higher cost).

Correct Answer: C. Net Interest Position Risk specifically addresses the impact of general market interest rate changes on NII arising from an imbalance between the total amount of rate-sensitive assets and liabilities.

Correct Answer: C. This is the standard definition of Operational Risk, covering failures within the bank’s operations and external factors.

Correct Answer: D. These are typical examples of failures or events that fall under the category of Operational Risk.

Correct Answer: B. Strategic Risk relates specifically to the outcomes of business plans, decisions, and their execution.

Correct Answer: C. Reputational Risk concerns damage to the bank’s image and standing in the eyes of the public, customers, and regulators.

Correct Answer: C. Model Risk arises when financial models used for pricing, risk assessment, etc., produce inaccurate results compared to reality.

Correct Answer: C. Flaws in model design, such as wrong assumptions or omitted variables, are key causes of Model Risk.

Correct Answer: B. Backtesting involves comparing a model’s past predictions to what actually happened to assess its accuracy and identify potential Model Risk.

Correct Answer: B. Climate Risk includes both the direct impacts of climate change and the impacts resulting from the transition towards a greener economy.

Correct Answer: D. Climate Risk is broadly divided into Physical Risks (direct impacts) and Transition Risks (impacts from societal changes).

Correct Answer: C. Physical Risks directly relate to the physical impacts of weather and climate phenomena.

Correct Answer: B. Transition Risks are associated with the changes in policy, technology, and market preferences as the economy moves away from fossil fuels and towards sustainability.

Correct Answer: C. The core driver is stated as maximizing the return expected after considering the associated risks.

Correct Answer: C. Management practices differ because business lines have varying levels of profitability and associated risks.

Correct Answer: B. Initially, NIM = 8% – 7% = 1%. After repricing, NIM = 8% – 7.5% = 0.5%. Change in NIM = 0.5% – 1% = -0.5%

Correct Answer: B. Initial interest rate = 5% + 4% = 9%. Initial annual interest = 9% of ₹100,000 = ₹9000. New Repo Rate = 5% + 0.5% = 5.5%. New interest rate = 5.5% + 4% = 9.5%. New annual interest = 9.5% of ₹100,000 = ₹9500

Correct Answer: A. Initial NIE = ₹5000 – ₹4500 = ₹500. The increase in the 91-day T-Bill rate will increase both the interest earned on the asset and the interest paid on the liability by the same proportion, assuming the same base amount. Thus, the NIE remains unchanged.

Correct Answer: C. Interest earned in the second year at the original rate = 6.0% of ₹50,000 = ₹3000. Interest earned in the second year at the new rate = 6.5% of ₹50,000 = ₹3250. Additional interest = ₹3250 – ₹3000 = ₹250

Correct Answer: C. The Trading Portfolio contains instruments actively traded for profit and is described as having higher risk than the banking book.

Correct Answer: C. Off-Balance Sheet Exposures are defined as contingent liabilities, such as guarantees and letters of credit.

Correct Answer: B. The Banking Book consists of assets (advances) and liabilities (deposits, borrowings) related to the bank’s core operations.

Correct Answer: B. Assets and liabilities within the Banking Book are typically held until their scheduled maturity date.

Correct Answer: C. Accrual accounting, where revenue/expenses are recognized when earned/incurred, is used for the Banking Book.

Correct Answer: B. The Banking Book is generally not subject to MTM valuation; its value is based on book value using accrual accounting.

Correct Answer: D. The capital requirement for the Banking Book is determined based on the credit risk associated with its assets.

Correct Answer: D. This is the definition of Credit/Default Risk as it applies to the loans held within the Banking Book.

Correct Answer: C. Operational Risk covers losses resulting from issues with internal processes, people, systems, or external events affecting Banking Book activities.

Correct Answer: C. Unlike the Banking Book, assets in the Trading Book are meant for active trading and are not typically held until maturity.

Correct Answer: C. The Trading Book uses MTM accounting, where assets are valued at their current market prices.

Correct Answer: B. Gains and losses from changes in the market value of Trading Book assets are recorded in the bank’s profit and loss statement.

Correct Answer: B. Market Risk for the Trading Book is the potential loss arising from changes in the market value of the traded assets.

Correct Answer: D. Liquidation Risk (or illiquidity risk) refers to the difficulty in selling a trading asset quickly at a fair market price.

Correct Answer: C. In the Trading Book context, Credit/Default Risk is mainly concerned with the failure of a trading partner (counterparty) to fulfill their side of a deal.

Correct Answer: C. The RBI norm specifies that “Held for Trading” securities should generally be sold within a 90-day period.

Correct Answer: C. Guarantees, committed credit lines, letters of credit, and derivatives are common examples of Off-Balance Sheet Exposures.

Correct Answer: B. These are contingent liabilities, meaning the bank’s obligation to pay only arises if the specific condition mentioned in the contract happens.

Correct Answer: B. Derivatives like swaps, futures, forwards, and options are explicitly mentioned as being considered off-balance sheet exposures.

Correct Answer: B. If the trigger event happens (e.g., a borrower defaults on a guaranteed loan), the off-balance sheet item becomes an actual asset or liability on the bank’s balance sheet.

Correct Answer: D. Despite being off-balance sheet initially, these exposures carry multiple risks similar to on-balance sheet items.