MINISTRY OF EDUCATION AND TRAINING FINAL EXAM

NATIONAL ECONOMICS UNIVERSITY

MANAGEMENT IN FINANCIAL INSTITUTIONS

Mode of study: Full time. Intake: 61

Exam place: MS Teams

School of Advanced Education Programs
Exam date: 04/10/2021 Exam time: 2

Version: No.1 Allowed time: 90 minutes

I: Multiple choice (30 points): These statements are True or False? (25 points/correct answer)

1. Demand deposits are among the most volatile and least predictable of a bank's sources of funds with
the shortest potential maturity TRUE

2. Loans from the Fed Funds market (interbank market) must be backed by collateral FALSE

 must not be backed

3. The borrower X has asked for a type of loan its lender normally refuses to make. This is Capacity in
6Cs when analyzing clients FALSE

 Control

4. The borrower Y has achieved higher earnings each year for the past six years. This is Cash in 6Cs
when analyzing clients TRUE

5. The borrower Z has an excellent credit rating. This is Character in 6Cs when analyzing clients TRUE

6. On a bank's income statement (Report of Income) deposit costs are financial outputs FALSE

 financial inputs

7. Loans and leases are financial inputs on a financial institution's balance sheet or Report of Condition
FALSE

 financial outputs

8. Recoveries on loans previously charged off are added to the Allowance for Loan Losses (ALL) account
on a bank's balance sheet TRUE

9. Off-balance-sheet items for a bank are fee generating transactions which are recorded on their balance
sheet FALSE

 are not recorded

10. The number one source of revenue for a bank based on dollar volume is interest and non-interest
income from investment FALSE

 loan income

11. The letter “C” in the CAMELS rating system for banks refers to the “Character” of a bank FALSE

 Capital adequacy

12. Retail credit in banking refers to such loans as residential mortgages and installment loans to
individuals TRUE

PART II: Assignments (30 points)

Assignment 1: What is the customer relationship doctrine, and what are the implications for fund-raising
by lending institutions? (10 points)

Answer:

- The customer relationship doctrine places lending to customers at the top of the priority list, which
proclaims that the first priority of a lending institution is to make loans to all those customers from whom
the lender expects to receive positive net earnings.

- The implications for fund-raising by lending institutions: all loans and investments whose returns
exceed their cost and whose quality meets the lending institution’s credit standards should be made.

Assignment 2: What are external and internal credit rating? What are the main differences? How can
credit rating help commercial banks in lending activities? (20 points)

Answer:

The quality of risk is often appraised through some form of credit ratings. In other words, credit ratings
are used to estimate the amount of credit that can be extended to a company or person without undue risk.

- External ratings are produced by independent rating agencies and aim at revealing the financial stability
of both lenders and borrowers.

- Internal ratings are banks’ own ratings used to undertake an independent assessment of the
creditworthiness of a specific borrower – either an individual or a corporate.

 The main difference between external and internal credit ratings is by whom they are developed:
Credit ratings may be internal to a bank or external when they come from a credit-rating agency.

Credit ratings are important because banks usually rely on customer deposits and money raised through
the issuance of various assets such as bonds to sustain lending. In addition, measuring the quality of risk
ultimately leads to quantifying the default probability of customers, plus the likelihood of any recovery
(how much of the loan or other debt can be recovered) in the event of default.
PART III: Exercises (40 points)

Exercise 1: (10 points) Suppose that a customer holds a savings deposit in a savings bank for a year. The
balance in the account stood at $5,000 for 150 days and $200 for the remaining days in the year. If the
Savings bank paid this depositor $40.50 in interest earnings for the year, what APY did this customer
receive?

Answer:

We use the formula below to calculate the APY this customer received:
365
Interest earned
APY = 100 x [(1+ ¿¿ Days ∈ period - 1]
Average account balance

$ 5,000 x 150+ $ 200 x 215

In which we can calculate: Average account balance = = $2,172.60
365

$ 40.50 365/365
Therefore, APY = 100 x [(1+ ) – 1] = 1.86%
$ 2,172.60

Exercise 2: (30 points) This is the 201X Balance Sheet of the Bank B with annually average figures

Amoun
Interest Risk Amount
t Interest
Assets rate weight Liabilities & Equity
(USD (USD rate (%)
(%) (%)
mil) mil)
Cash and deposits due 150   1,500 1
0 Demand deposit
from banks
3-month Treasury 550 1 3-month bank 800 5
100
Bills deposits

5-year fixed-rate 450 3 6-month corporate 2,750 11

0
Government Bonds deposits

12-month floating-rate 2,950 12 Non-deposit 1450 16

100
corporate loans borrowings

10 year fixed-rate 2,500 17 650  

50 Equity
mortgage loans
Fixed assets 550   100      

This Bank earned USD 550 mil in fees and commissions and USD 20 mil in securities gain; paid USD
250 mil in overhead costs; USD 950 in loan loss provision. Tier 1 capital was equal to 35% of equity and
Tier 2 capital was equal to 10% of non-deposit borrowings, deduction is USD 15 mil. Corporate income
tax rate is 18%.

a. How much are: Net interest margin, ROE, CAR (20 points).
Answer:

Interest income is: 550 x 1% + 450 x 3% + 2,950 x 12% + 2,500 x 17% = $798 mil

Interest expense is: 1,500 x 1% + 800 x 5% + 2,750 x 11% + 1,450 x 16% = $589.5 mil

Net income is: 550 + 20 – 250 – 0.00095 = $319.99905 mil

Total assets: 150 + 550 + 450 + 2,950 + 2,500 + 550 = $7,150 mil

Net interest margin = (Interest income - Interest expense)/(Total assets) = (789 – 589.5)/7,1500 = 0.02916

 Net interest margin is 2.916%

Return on equity capital (ROE) = (Net income)/(Total equity capital) = 319.99905/650 = 0.492 or 49.2%

 ROE = 49.2%

Tier 1 capital = 650 x 35% = $227.5 mil

Tier 2 capital = 1,450 x 10% - 15 = $130 mil

Total risk-weighted assets = 150 x 0% + 550 x 100% + 450 x 0% + 2,950 x 100% + 2,500 x 50% + 550 x
100% = $5,300 mil

Capital adequacy ratio (CAR) = (Tier 1 capital + Tier 2 capital)/(Total risk-weighted assets) = (227.5 +
130)/(5,300) = 0.06745 or 6.745%.

 CAR = 6.745%

b. Assessing the capital adequacy level of the bank if minimum CAR should be 8%. How could the
bank improve its capital adequacy level (10 points).

Answer:

The bank’s CAR equals 6.745%, which is smaller than the minimum CAR of 8%. Therefore, it can be
said that the capital adequacy level of the bank is low. As CAR equals (Tier 1 capital + Tier 2
capital)/(Total risk-weighted assets); to improve its capital adequacy level, the bank can either increase its
levels of regulatory capital or decrease its risk-weighted assets.

Note: Closed book - one page of formulas is allowed