Banking Banking Fundamentals 3 — Questions and Answers
Question 1: What is 'fractional reserve banking'?
- A system where banks hold only a fraction of deposits as reserves and lend the rest (Correct answer)
- A method of splitting a bank's assets into fractions for investment
- A practice where multiple banks share a single reserve pool
- A partial insurance system covering only a fraction of deposits
Correct answer: A system where banks hold only a fraction of deposits as reserves and lend the rest
Fractional reserve banking allows banks to lend out most deposited funds while keeping only a small fraction in reserve, enabling money creation in the economy.
Question 2: What is a 'correspondent bank'?
- A bank that communicates loan offers to potential customers by mail
- A bank that provides services to another bank, typically to facilitate international transactions (Correct answer)
- A bank specializing in communications and media industry clients
- A backup bank appointed to handle accounts if the primary bank fails
Correct answer: A bank that provides services to another bank, typically to facilitate international transactions
Correspondent banks act as intermediaries for other financial institutions, providing services like wire transfers and foreign exchange in locations where the other bank has no presence.
Question 3: What does 'charge-off' mean in banking terminology?
- A fee charged by the bank for account maintenance
- The amount a bank removes from its books as a loss when a loan is deemed uncollectible (Correct answer)
- Interest charges added to an overdue account
- A penalty charged for early withdrawal of a CD
Correct answer: The amount a bank removes from its books as a loss when a loan is deemed uncollectible
A charge-off occurs when a bank writes off a loan balance as a loss, typically after payments are 180 days past due, though collection efforts may continue.
Question 4: What is the role of the Consumer Financial Protection Bureau (CFPB)?
- To insure consumer deposits up to $250,000
- To regulate and supervise financial products and services to protect consumers (Correct answer)
- To set monetary policy for the U.S. economy
- To prosecute banks that engage in securities fraud
Correct answer: To regulate and supervise financial products and services to protect consumers
The CFPB, created by the Dodd-Frank Act in 2010, supervises financial institutions and enforces consumer financial protection laws.
Question 5: What is a 'balloon payment' in a loan?
- A small initial payment made before the first regular installment
- A large lump-sum payment due at the end of a loan term (Correct answer)
- Extra payments a borrower makes to reduce principal faster
- A penalty fee triggered when a loan exceeds its credit limit
Correct answer: A large lump-sum payment due at the end of a loan term
A balloon payment is a large final payment required at the end of a loan that wasn't fully amortized through regular installments.
Question 6: Which of the following best describes 'credit risk'?
- The risk that interest rates will rise and reduce the value of a bond
- The risk that a borrower will fail to repay a loan as agreed (Correct answer)
- The risk of losses due to operational failures within the bank
- The risk that a bank's stock price will decline
Correct answer: The risk that a borrower will fail to repay a loan as agreed
Credit risk is the possibility that a borrower or counterparty will default on their obligation, resulting in a financial loss for the lender.
Question 7: What is the purpose of a 'loan-to-value (LTV) ratio'?
- To measure the profitability of a loan for the bank
- To express the ratio of a loan amount to the appraised value of the collateral (Correct answer)
- To calculate the monthly payment on an amortizing loan
- To determine the maximum interest rate applicable to a loan
Correct answer: To express the ratio of a loan amount to the appraised value of the collateral
The LTV ratio helps lenders assess lending risk by comparing the loan amount to the collateral's value; higher LTV means more risk for the lender.
Banking Banking Fundamentals 3
What is 'fractional reserve banking'?