Banking Exam Commercial Bank 5 — Questions and Answers
Question 1: What is the primary difference between a 'secured' and an 'unsecured' commercial bank loan?
- Secured loans carry higher interest rates because of added administrative costs
- Secured loans are backed by collateral the lender can claim upon default; unsecured loans rely solely on the borrower's creditworthiness (Correct answer)
- Unsecured loans are only available to government entities
- Secured loans are always short-term; unsecured loans are always long-term
Correct answer: Secured loans are backed by collateral the lender can claim upon default; unsecured loans rely solely on the borrower's creditworthiness
Collateral in a secured loan gives the lender a secondary repayment source, reducing risk, while unsecured lending depends entirely on the borrower's ability and willingness to repay.
Question 2: What does 'Tier 1 capital' represent for a commercial bank under Basel III?
- Total deposits and other borrowed funds
- Core capital, primarily consisting of common equity and retained earnings, used to absorb losses on a going-concern basis (Correct answer)
- Subordinated debt and hybrid instruments qualifying as supplemental capital
- The bank's total assets minus its risk-weighted assets
Correct answer: Core capital, primarily consisting of common equity and retained earnings, used to absorb losses on a going-concern basis
Tier 1 capital is the highest-quality capital, dominated by common equity Tier 1 (CET1), and is the primary buffer against insolvency.
Question 3: Which of the following best describes 'money laundering' risk in commercial banking?
- The risk that loan collateral depreciates before a default occurs
- The risk that criminals use bank accounts and transactions to disguise illegally obtained funds as legitimate income (Correct answer)
- The risk of operational losses due to employee misconduct
- The risk that foreign exchange transactions expose the bank to currency losses
Correct answer: The risk that criminals use bank accounts and transactions to disguise illegally obtained funds as legitimate income
Money laundering involves processing criminal proceeds through the banking system to make illegal funds appear legitimate, exposing banks to regulatory and reputational risk.
Question 4: What is a 'prime rate' in U.S. commercial banking?
- The interest rate the Federal Reserve charges banks for overnight loans at the discount window
- A benchmark lending rate commercial banks offer to their most creditworthy customers, typically set at 3% above the federal funds rate (Correct answer)
- The average rate banks pay on certificates of deposit
- The rate at which banks buy and sell Treasury securities
Correct answer: A benchmark lending rate commercial banks offer to their most creditworthy customers, typically set at 3% above the federal funds rate
The prime rate is a reference rate used to price loans to top-tier borrowers and historically has been maintained at approximately 3 percentage points above the federal funds rate.
Question 5: When a commercial bank sells a group of mortgage loans to an investor, converting them into securities, this process is called:
- Loan participations
- Securitization (Correct answer)
- Loan syndication
- Secondary market lending
Correct answer: Securitization
Securitization pools loans into securities (e.g., mortgage-backed securities) sold to investors, allowing banks to recycle capital and transfer credit risk off their balance sheets.
Question 6: A commercial bank's 'efficiency ratio' is calculated as:
- Net interest income divided by total assets
- Non-interest expense divided by net revenue (net interest income plus non-interest income) (Correct answer)
- Loan losses divided by total loans outstanding
- Return on assets divided by return on equity
Correct answer: Non-interest expense divided by net revenue (net interest income plus non-interest income)
The efficiency ratio measures how much of a bank's revenue is consumed by operating expenses; a lower ratio indicates a more cost-efficient operation.
Question 7: What is the role of the FDIC in U.S. commercial banking?
- Setting monetary policy and the federal funds rate target
- Insuring deposits up to $250,000 per depositor per insured bank and resolving failed banks (Correct answer)
- Chartering all state-chartered commercial banks
- Regulating bank holding companies and their non-bank subsidiaries
Correct answer: Insuring deposits up to $250,000 per depositor per insured bank and resolving failed banks
The FDIC insures eligible deposits and acts as receiver for failed FDIC-insured institutions, protecting depositors and maintaining confidence in the banking system.
Banking Exam Commercial Bank 5
What is the primary difference between a 'secured' and an 'unsecured' commercial bank loan?