Banking Exam Credit Risk and Analysis 5 — Questions and Answers
Question 1: A bank classifies a loan as 'doubtful.' Under OCC guidelines, this means:
- The loan is performing but monitored closely
- The loan has all the weaknesses of a substandard loan plus collection is highly questionable (Correct answer)
- The loan has been charged off
- The loan is guaranteed by the SBA
Correct answer: The loan has all the weaknesses of a substandard loan plus collection is highly questionable
Doubtful classification indicates full collection is highly improbable, though the loss amount may not yet be determinable, making it one step below 'loss.'
Question 2: What is the purpose of a 'credit risk appetite statement' at a bank?
- To set the bank's deposit interest rate strategy
- To define the types and levels of credit risk the bank is willing to accept in pursuit of its objectives (Correct answer)
- To outline the bank's marketing strategy for new loan products
- To determine individual loan officer compensation
Correct answer: To define the types and levels of credit risk the bank is willing to accept in pursuit of its objectives
A credit risk appetite statement formally defines acceptable risk levels, guiding portfolio management and individual credit decisions across the institution.
Question 3: In analyzing a small business loan, a lender finds that 80% of revenue comes from one customer. This is best described as:
- A positive diversification indicator
- Customer concentration risk that threatens revenue stability (Correct answer)
- Evidence of strong brand loyalty
- A sign of efficient operations
Correct answer: Customer concentration risk that threatens revenue stability
Heavy reliance on a single customer creates fragile cash flows — loss of that customer could immediately impair the borrower's ability to service debt.
Question 4: Which of the following best defines 'counterparty credit risk' in banking?
- The risk that a retail borrower defaults on a mortgage
- The risk that the other party in a financial contract will default before the contract's settlement (Correct answer)
- The risk of fraudulent loan applications
- The risk of interest rate changes affecting loan value
Correct answer: The risk that the other party in a financial contract will default before the contract's settlement
Counterparty credit risk arises in derivatives, securities financing, and other bilateral contracts where one party may fail to fulfill its obligations.
Question 5: A bank reviews a borrower's 'global cash flow' by including the owner's personal tax returns alongside business financials. Why?
- To comply with anti-money laundering regulations
- To capture all income sources and debt obligations that affect the owner's total repayment capacity (Correct answer)
- To determine the borrower's personal net worth for collateral purposes
- To satisfy FDIC deposit insurance requirements
Correct answer: To capture all income sources and debt obligations that affect the owner's total repayment capacity
Global cash flow analysis combines business and personal finances to assess whether the owner's total obligations can be serviced by combined income streams.
Question 6: What does a 'credit watch' designation from a rating agency typically signal?
- The issuer's rating has been permanently downgraded
- The issuer is under review for a possible rating change in the near term (Correct answer)
- The issuer has defaulted on a payment
- The issuer's outlook has been changed to stable
Correct answer: The issuer is under review for a possible rating change in the near term
Credit watch indicates an imminent review that could result in an upgrade, downgrade, or affirmation, typically resolved within 90 days.
Question 7: Which financial metric is most useful for assessing a company's short-term liquidity in credit analysis?
- Debt-to-equity ratio
- Current ratio (Correct answer)
- Return on equity (ROE)
- Net profit margin
Correct answer: Current ratio
The current ratio (current assets ÷ current liabilities) measures whether a borrower can cover near-term obligations with liquid assets.
Banking Exam Credit Risk and Analysis 5
A bank classifies a loan as 'doubtful.' Under OCC guidelines, this means: