Banking Exam Commercial Bank 3 — Questions and Answers
Question 1: A commercial bank's 'spread' in lending refers to:
- The geographic reach of its branch network
- The difference between the interest rate charged on loans and the cost of funds (Correct answer)
- The range of products offered to retail customers
- The gap between prime rate and federal funds rate
Correct answer: The difference between the interest rate charged on loans and the cost of funds
The lending spread is the margin between what the bank charges borrowers and what it pays depositors or for borrowed funds.
Question 2: What is a 'standby letter of credit' issued by a commercial bank?
- A revolving credit facility for small businesses
- A guarantee that the bank will pay a beneficiary if the bank's customer fails to meet a contractual obligation (Correct answer)
- A document certifying a customer's creditworthiness
- An instrument used to finance import/export transactions directly
Correct answer: A guarantee that the bank will pay a beneficiary if the bank's customer fails to meet a contractual obligation
A standby letter of credit is a payment guarantee; the bank pays the beneficiary only if the applicant (customer) defaults on an obligation.
Question 3: Which of the following best describes 'asset-liability management' (ALM) at a commercial bank?
- Managing loan collections and non-performing assets
- Coordinating a bank's assets and liabilities to maximize profitability while managing interest rate and liquidity risk (Correct answer)
- Setting the bank's investment policy for its securities portfolio
- Overseeing the bank's capital raising activities
Correct answer: Coordinating a bank's assets and liabilities to maximize profitability while managing interest rate and liquidity risk
ALM involves strategically balancing assets (loans, investments) and liabilities (deposits, borrowings) to optimize the bank's net interest margin while controlling risk.
Question 4: What is a 'loan-to-value' (LTV) ratio used to assess in commercial banking?
- The profitability of a loan relative to operating costs
- The risk of a secured loan by comparing the loan amount to the appraised value of the collateral (Correct answer)
- The ratio of commercial loans to consumer loans in a bank's portfolio
- A bank's exposure to a single borrower relative to its capital
Correct answer: The risk of a secured loan by comparing the loan amount to the appraised value of the collateral
LTV measures collateral coverage; a higher LTV means more risk for the lender because there is less cushion if the borrower defaults and the collateral must be liquidated.
Question 5: In the U.S., which federal agency primarily charters and supervises national commercial banks?
- Federal Deposit Insurance Corporation (FDIC)
- Office of the Comptroller of the Currency (OCC) (Correct answer)
- Consumer Financial Protection Bureau (CFPB)
- Securities and Exchange Commission (SEC)
Correct answer: Office of the Comptroller of the Currency (OCC)
The OCC charters, regulates, and supervises all national banks and federal savings associations.
Question 6: What is the purpose of a commercial bank's 'allowance for loan and lease losses' (ALLL)?
- A reserve set aside for operational costs related to loan processing
- An accounting reserve representing estimated losses on loans that have not yet been charged off (Correct answer)
- A fund used to reimburse customers for fraudulent transactions
- Capital set aside to satisfy regulatory capital requirements
Correct answer: An accounting reserve representing estimated losses on loans that have not yet been charged off
The ALLL is a contra-asset account that reduces the gross loan portfolio to its estimated net realizable value by reserving for expected credit losses.
Question 7: Which of the following is an example of 'off-balance-sheet' activity by a commercial bank?
- Holding U.S. Treasury securities in the investment portfolio
- Issuing loan commitments and letters of credit not yet funded (Correct answer)
- Accepting customer demand deposits
- Maintaining required reserves at the Federal Reserve
Correct answer: Issuing loan commitments and letters of credit not yet funded
Loan commitments and letters of credit create contingent liabilities that do not appear on the balance sheet until drawn upon.
Banking Exam Commercial Bank 3
A commercial bank's 'spread' in lending refers to: