RAROC and Profit Planning MCQ: CAIIB BFM Unit 31 Module D

Correct Answer: B. Strategically managing the bank’s balance sheet. Profit planning involves the strategic management of assets and liabilities shown on the bank’s balance sheet to maximize profitability.

Correct Answer: C. Revenue earned from lending money and investments. Interest income is the money banks earn from interest on loans they give out and returns from their investments in securities.

Correct Answer: C. They offer potentially higher returns but need more capital due to risk. While riskier loans can yield higher interest income, banks must set aside more capital to cover potential losses as per risk weighting.

Correct Answer: C. They reduce interest income and increase the need for capital reserves. NPAs stop generating interest income and are treated as riskier assets, requiring the bank to hold more capital against them.

Correct Answer: B. Revenue generated from services like drafts, remittances, and internet banking. Fee-based income comes from charging customers for various non-lending services provided by the bank.

Correct Answer: C. By enabling the growth of fee-based income streams. Technology allows banks to offer more services (like internet banking, financial supermarkets) efficiently, increasing opportunities for fee income.

Correct Answer: C. Profit or loss from trading in securities, forex, and derivatives. Treasury income arises from the bank’s activities in financial markets, buying and selling various financial instruments.

Correct Answer: C. Implementing strict risk management and internal controls. Due to the potential for large profits and losses, treasury operations require strong controls like position limits and mark-to-market valuations.

Correct Answer: C. The costs associated with managing the bank’s deposit portfolio. Interest expenses are mainly the interest the bank pays to its customers for keeping money in current, savings, and term deposit accounts.

Correct Answer: C. It helps in reducing the bank’s overall interest expenses. Current Account and Savings Account (CASA) deposits generally have very low or zero interest rates, making them a cheap source of funds for the bank compared to term deposits.

Correct Answer: C. Prevailing market forces and competitor actions. Term deposit rates are largely determined by the overall interest rate environment in the economy and the rates offered by competing banks.

Correct Answer: C. Staff salaries, benefits, depreciation, rent, and utilities. Operating expenses cover the day-to-day costs of running the bank, excluding interest expenses but including staff costs and overheads.

Correct Answer: B. Improving staff productivity and operating cost efficiency. Banks aim to manage costs effectively by making their staff more productive and controlling overhead expenses.

Correct Answer: B. Interest Income, Fee Income, Trading Income, and various Expenses. Bank profitability is determined by the interplay of its various income sources (interest, fees, trading) and its expenses (interest, staff, operating).

Correct Answer: B. By requiring banks to maintain specific levels of capital adequacy. Basel Norms mandate that banks hold a certain amount of capital relative to their risk-weighted assets, which affects lending capacity and overall profitability.

Correct Answer: B. They determine the amount of capital a bank must hold against different asset types. Different assets (like loans or investments) have different risk levels, and RWA assigns weights to these assets to calculate the minimum capital the bank needs to hold.

Correct Answer: B. To identify and evaluate the total risk exposure across all activities. Risk aggregation is the process of combining different risk exposures within a bank to get an overall view of the total risk.

Correct Answer: B. The performance of business units relative to the economic capital needed for their risks. RAROC assesses profitability after considering the amount of capital required to cover the risks taken by a business unit.

Correct Answer: B. The anticipated, average losses that banks plan for using provisions. Expected losses are the statistically predictable losses inherent in banking operations, managed through standard reserves.

Correct Answer: D. Economic Capital. Unexpected losses are potential losses beyond the average expectation, and banks hold Economic Capital as a buffer against these significant, less predictable events.

Correct Answer: C. Based on the level of risk, measured by income volatility. RAROC allocates more capital to activities with higher risk (higher volatility or standard deviation of income) and demands higher returns from them.

Correct Answer: B. The potential volatility or change in net interest income or earnings. EaR measures how much a bank’s earnings could potentially fluctuate due to factors like interest rate changes.

Correct Answer: C. It directly shows the potential impact of risk on current earnings. EaR helps management understand how risks, especially market risks, could affect the bank’s immediate profitability.

Correct Answer: C. It may not fully show how interest rate changes affect the market value of assets. EaR focuses on income volatility but might not capture the full impact on the underlying value of the bank’s assets and liabilities due to rate changes.

Correct Answer: B. Assumptions about the potential range of market movements. Estimating EaR involves making assumptions about how much interest rates or other market factors might change (e.g., worst-case scenarios), which can be subjective.

Correct Answer: C. A capital buffer held to absorb significant unexpected losses. Economic Capital is the extra cushion banks maintain specifically to survive large, unforeseen losses arising from their risk exposures.

Correct Answer: B. RAROC includes a risk-adjusted perspective using risk capital. Unlike ROA (Return on Assets) and ROE (Return on Equity), RAROC explicitly factors in the amount of economic capital needed to support the risk taken, giving a better risk-adjusted view of performance.

Correct Answer: C. Using Value at Risk (VaR) considering exposure, volatility, and confidence level. VaR models are frequently used to estimate the potential loss at a certain confidence level, which forms the basis for calculating the required Risk Capital.

Correct Answer: B. Profit / Risk Capital (RC). RAPM assesses performance by comparing the profit generated to the amount of risk capital allocated to the activity.

Correct Answer: C. Allocating capital based on VaR parameters like confidence level. The RAROC process involves measuring risk, allocating capital based on that risk (often using VaR), and then measuring performance adjusted for that allocated capital.

Correct Answer: C. The true economic profit after deducting the cost of capital. EVA determines if a business is generating profit over and above the cost of the capital (both debt and equity) used to generate that profit.

Correct Answer: C. EVA = Profit – (Capital x k). EVA is calculated by taking the net operating profit after tax and subtracting a charge for the capital employed, where ‘k’ represents the cost of that capital.

Correct Answer: C. The business unit or project is creating shareholder value. A positive EVA means the returns generated exceed the cost of the capital used, indicating true economic profit and value creation for shareholders.

Correct Answer: B. Regional Rural Banks. The Indian Banking Sector includes various types of banks such as Public Sector Banks, Private Sector Banks (New and Old Generation), Co-operative Banks, Regional Rural Banks, Small Finance Banks, and Payment Banks.

Correct Answer: C. To finance infrastructure projects in India. NaBFID is a specialized Development Financial Institution (DFI) created specifically to support the financing of large-scale infrastructure development in the country.

Correct Answer: C. Funds raised from capital markets or provided by the government. NaBFID obtains its funding through market borrowings, government support, and funds from multilateral institutions like the World Bank or ADB.

Correct Answer: B. Accepting deposits from the public. Unlike commercial banks, NaBFID, as a DFI focused on infrastructure financing, is not allowed to take deposits from the general public.