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SCHOOL OF BANKING AND FINANCE

FINS5530 – FINANCIAL INSTITUTION MANAGEMENT

FINAL Examination – T3 2023

INSTRUCTIONS:

1. TIME ALLOWED – THIS IS A TAKE HOME EXAMINATION. TO BE RELEASED VIA MOODLE AT 8PM (SYDNEY TIME) ON 24 NOVEMBER 2023. SUBMISSION IS DUE AT BY 11.59 (SYDNEY TIME), MONDAY 27 NOVEMBER 2023 VIA MOODLE.

2. TOTAL NUMBER OF QUESTIONS TO BE ANSWERED – 4 WORTH 10 MARKS EACH (INCLUDING SUB-PARTS).

3. THIS EXAM IS WORTH 35% OF THE TOTAL MARKS FOR THE COURSE.

4. MARKS AVAILABLE FOR EACH QUESTION ARE SHOWN IN THE PAPER

5. STUDENTS ARE ADVISED TO CAREFULLY READ THE EXAMINATION QUESTIONS BEFORE ATTEMPTING TO ANSWER THE QUESTIONS

6. THIS EXAM CANNOT BE COPIED, FORWARDED, OR SHARED IN ANY WAY

7. STUDENTS ARE REMINDED OF THE UNSW RULES REGARDING ACADEMIC INTEGRITY AND PLAGIARISM

8. THE STUDENT’S FULL NAME, zID, STUDENT’S UNSW EMAIL ADDRESS SHOULD APPEAR ON THE UNSW BUSINESS SCHOOL ASSIGNMENT COVER (PROVIDED) TO BE USED FOR THIS EXAM

NOTES:

1. THIS EXAM IS OPEN BOOK

2. PLEASE USE THIS EXAM DOCUMENT TO COMPILE YOUR ANSWERS FOR SUBMISSION

3. UPON COMPLETION, CONVERT THE DOCUMENT INTO A PDF FILE AND SUBMIT IT VIA THE LINK PROVIDED IN THE ASSESSMENTS SECTION OF THIS COURSE’S MOODLE SITE

4. PRIOR TO ATTEMPTING THE EXAM, STUDENTS MUST READ THE STUDENT DECLARATION

5. THERE IS NO WORD LIMIT BUT BREVITY AND A PROFESSIONAL PRESENTATION ARE EXPECTED

Question 1. Operational and Technological Risk

1.1. The standardised measurement approach (standardised approach or SMA) for calculating operational risk capital under Basel III regulation was implemented in 2023 (see the report at OPE25 - Standardised approach (bis.org)) and its replaces the Advanced Measurement Approach (AMA). This new approach estimates regulatory capital requirement based on two parameters, Business Indicator Component (BIC) and Internal Loss Multiplier (ILM). Explain the rationale of using each of these two parameters for calculation of capital requirement. Further, discuss what you consider to be any two key weaknesses of SMA. [3 marks]

1.2. In the course, we discussed certain principles for sound management of operational risk, recommended by the Basel Committee (please see the report at https://www.bis.org/bcbs/publ/d515.htm). One of the principles (Principle 7) emphasises the importance of senior management’s role in proactively managing operational risks when a bank initiates major changes (e.g. implementing new or modifying business processes or technology systems). We also learnt that artificial intelligence (AI) is poised to bring transformational change to banking (see McKinsey article, at AI in banking: Can banks meet the challenge? | McKinsey).

Answer the following questions in the context of managing operational risk (you may use the references at the links cited above or any other references to support your arguments).

a) Evaluate any three key benefits which a bank may realise by integrating AI into its business operations. [3 marks]

b) Identify any three key risks to banks emanating from their adoption of AI in managing their business. Further, clearly explain the causes and consequences of these risks. You may use examples to support your discussion. [4 marks]

Question 2. Market Risk

Refer to the following materials accompanying the Case “Implementing Quantitative Risk Management and VaR at a Chinese Investment Bank” covered in Lecture 9:

• Case Implementing VaR at a Chinese Investment Bank

• Spreadsheet accompanying VaR in Chinese Investment Bank Case

Using the spreadsheet provided with the lecture materials, run backtests of the VaR predictions against actual daily gains or losses for both the S&P500 Index and the Shanghai Composite Index.

2.2. Consider the statement, “VAR is not suited for an emerging market. It can only be used in advanced economies like the U.S.”. Based on your backtesting with the Excel spreadsheet and providing evidence from this exercise, comment on this statement. [2 marks]

2.3. Consider the following statement: “A VaR value indicates how large a bank’s losses can get during stressful periods where markets are facing economic losses and it gives consideration to losses beyond the confidence level.” Evaluate whether this statement true of usage of VaR, clearly indicating whether what you see in the Case supports it or not. [4 marks]

2.4. Why is Expected Shortfall considered to be an improvement over VAR? Ensure you refer to your knowledge of distributions and tails. (Note – you are not expected to specifically calculate Expected Shortfall). [4 marks]

Question 3. Capital management

Consider the following extract from a recent news article:

Elon Musk gives X employees one year to replace your bank

Elon Musk wants X to be the center of your financial world, handling anything in your life that deals with money. He expects those features to launch by the end of 2024, he told X employees during an all-hands call on Thursday, saying that people will be surprised with “just how powerful it is.”

3.1. In your opinion and based on your knowledge of bank regulation, will Elon Musk succeed in his quest? You answer should address the factors that favour this proposal as well as those that work against it [3 marks].

3.2. During this term’s lectures we discussed the case summarised in the attached article “Final Exam Supporting Document: Volt Bank to close, return $100 million in deposits to customers”. Based on your evaluation of what happened to Volt Bank [3 marks].

3.3. Visit the websites of each of the following banks: National Australia Bank, Commonwealth Bank, Westpac Banking Corporation and ANZ Bank. From the banks’ financial statements, identify and list the four banks’ capital adequacy ratios and then answer the following questions:

a) Calculate the average of the capital adequacy ratios. Relative to this average, comment on the safety of Australia’s banking system if you were to assume the market only comprises these four banks [2 marks].

b) Evaluate the statement: “A bank can never have too much capital. If a bank manager wants to be certain the bank is safe, they must keep as much capital as possible”. Your answer must reflect economic arguments about the value of capital [2 marks].Page 5

Question 4. Securitisation

1. Why should a bank use securitisation if it can simply use loan sales? Your answer must show your understanding of the advantages of using securitisation. [4 marks]

2. How do banks make money out of securitisation? [2 marks]

3. You have heard that securitisation caused the Global Financial Crises of 2007-2009. Critically evaluate this statement. [4 marks].