1. What is the primary function of a commercial bank?
A. Accepting deposits and making loans
B. Issuing government securities
C. Advising on mergers and acquisitions
D. Managing mutual funds
Commercial banks are primarily involved in taking deposits from customers and providing loans.
2. Retail banks primarily serve which type of customers?
A. Large corporations
B. Individuals and small businesses
C. Government agencies
D. Multinational companies
Retail banks are a part of commercial banks that cater primarily to individuals and small businesses.
3. What is one of the main functions of investment banks?
A. Accepting savings deposits
B. Issuing debit and credit cards
C. Assisting in raising capital and advising on mergers
D. Providing locker facilities
Investment banks specialize in helping companies raise funds and advise them on corporate finance matters.
4. Whether a bank can engage in both commercial and investment banking depends on:
A. The size of the bank
B. The number of employees
C. The capital adequacy ratio
D. The regulations of the country it operates in
Whether a bank can operate in both commercial and investment domains depends on the specific banking regulations of the country it operates in.
5. What are the three main types of risks typically faced by a bank?
A. Inflation risk, deflation risk, liquidity risk
B. Regulatory risk, credit card fraud, interest risk
C. Credit risk, market risk, operational risk
D. Insurance risk, capital risk, compliance risk
The three key risks faced by banks are credit risk, market risk, and operational risk, as they directly impact the bank’s core functions.
6. Credit risk primarily arises from which of the following situations?
A. Borrowers failing to repay their loans
B. Losses from trading government bonds
C. Errors in financial statements
D. Delay in salary payments to employees
Credit risk refers to the risk that a borrower will default on loan obligations or that a counterparty in a financial contract will fail to fulfill its side of the agreement.
7. Which of the following is an example of market risk?
A. Loan default by a customer
B. Employee misconduct
C. Cyber attack on IT systems
D. Fluctuation in stock or interest rates
Market risk arises from trading activities and includes changes in prices of securities, interest rates, stock prices, and exchange rates.
8. Which of the following is NOT a cause of operational risk?
A. Cyber attacks
B. Loan repayment default
C. IT system failures
D. Business interruption
Loan defaults are part of credit risk, not operational risk. Operational risks come from system failures, cyber threats, human error, and internal control issues.
9. When a bank acts as a market maker for investors, it is exposed to:
A. Operational risk only
B. Credit risk only
C. Controlled market risk
D. No risk
As a market maker, banks facilitate trading and assume controlled exposure to market risk through financial instruments.
10. What is the primary purpose of equity capital in a bank?
A. To cover losses while the bank continues operations
B. To repay short-term liabilities
C. To pay interest to depositors
D. To ensure compliance with tax regulations
Equity capital acts as a buffer against losses and supports the bank's solvency as a going concern—when the bank is still operational.
11. What does economic capital represent in a banking context?
A. Capital mandated by central government policies
B. Capital used only during liquidation
C. Total paid-up capital of shareholders
D. Capital estimated by the bank using internal risk models
Economic capital is the amount of capital a bank internally estimates it needs to cover unexpected losses, based on its own risk assessments.
12. What best describes regulatory capital?
A. Capital determined by the bank's internal auditors
B. Minimum capital required by banking regulators
C. Maximum credit offered by regulators
D. Capital maintained for operational expenses
Regulatory capital is the minimum capital a bank must maintain as per regulatory requirements, ensuring it can absorb losses and remain solvent.
13. Debt capital in a bank is considered:
A. Going concern capital
B. Core Tier 1 capital
C. Gone concern capital
D. Temporary capital reserve
Debt capital is considered "gone concern" capital because it is intended to absorb losses when a bank ceases operations.
14. What do economic capital and regulatory capital have in common?
A. Both are used to cover unexpected losses
B. Both are issued by the government
C. Both are calculated by regulators
D. Both are invested in stock markets
Both economic and regulatory capital are held by banks to absorb unexpected losses and ensure financial stability.
15. What was the original focus of Basel Committee capital regulations?
A. Credit risk only
B. Liquidity risk only
C. Operational risk only
D. Market risk only
The Basel regulations initially focused on credit risk—ensuring banks had sufficient capital to cover potential defaults on loans and derivatives.
16. Over time, what additional risks were included in Basel capital requirements?
A. Liquidity risk and interest rate risk
B. Settlement risk and fraud risk
C. Credit valuation adjustment and model risk
D. Market risk and operational risk
Basel regulations evolved to include market risk and operational risk, in addition to the original credit risk component.
17. What are the two key liquidity ratios introduced by the Basel Committee post-2007-09 crisis?
A. Capital adequacy ratio and leverage ratio
B. Liquidity coverage ratio (LCR) and net stable funding ratio (NSFR)
C. Asset quality ratio and funding adequacy ratio
D. Current ratio and quick ratio
LCR ensures short-term liquidity for 30 days of stress, and NSFR addresses long-term funding and maturity mismatches.
18. Under current Basel norms, when can a bank use internal models for capital computation?
A. Always, without any approval
B. Only for operational risk
C. If approved by the national regulator, for market and credit risks
D. Never, as internal models are banned
Banks can use internal models for market and credit risks only with approval from their national regulators; operational risk must use standardized models.
19. According to the Basel regulations, internal model capital must be at least:
A. 85% of Tier 1 capital
B. 60% of risk-weighted assets
C. 72.5% of Tier 2 capital
D. 72.5% of capital calculated using the standardized model
Basel regulations mandate that internal model outputs must be no less than 72.5% of the capital required under standardized models—this rule applies by 2027.
20. What is the main objective of maintaining regulatory capital in banks?
A. To ensure compliance with tax rules
B. To increase bank profitability
C. To absorb unexpected losses and protect depositors
D. To manage marketing and outreach expenses
Regulatory capital acts as a buffer to absorb unexpected losses, ensuring the bank can continue to operate and depositors are protected.
21. Which of the following best describes the difference between economic capital and regulatory capital?
A. Economic capital is imposed by regulators; regulatory capital is internal
B. Economic capital is based on internal risk models; regulatory capital is set by regulators
C. Economic capital applies to liquidity risk only; regulatory capital covers all risks
D. There is no difference; both are identical
Economic capital is estimated internally by banks based on their own assessment of risks, whereas regulatory capital is the minimum capital mandated by regulators.
22. What is the primary objective of the Liquidity Coverage Ratio (LCR)?
A. To ensure the bank has enough liquidity for a 30-day stress scenario
B. To monitor the bank's operational risk events
C. To reduce interest rate risk
D. To improve the capital adequacy ratio
The LCR ensures that a bank holds enough high-quality liquid assets to survive a 30-day period of financial stress.
23. The Net Stable Funding Ratio (NSFR) is designed to:
A. Ensure sufficient short-term borrowing
B. Increase trading activity
C. Limit loan disbursement in rural areas
D. Address mismatches between asset and liability maturities
NSFR ensures that long-term assets are funded with at least a minimum amount of stable funding, reducing liquidity risk from asset-liability mismatches.
24. According to the Basel Committee, what was one major cause of the 2007–2009 financial crisis?
A. Excess capital reserves
B. Low operational risk
C. Liquidity shortages rather than capital shortages
D. Over-regulation of small banks
The Basel Committee identified that the crisis was primarily due to a lack of liquidity in financial institutions, not merely a lack of capital.
25. What is the primary purpose of deposit insurance in the banking system?
A. To increase bank profits
B. To guarantee bank loans
C. To increase public confidence and prevent bank runs
D. To reduce interest rates
Deposit insurance is designed to maintain public trust in the banking system by protecting depositors' money in case of bank failures, thereby preventing mass withdrawals or "bank runs."
26. What is meant by the term "moral hazard" in the context of deposit insurance?
A. Banks becoming more transparent
B. Insured parties taking greater risks than they would if not insured
C. Depositors withdrawing funds too frequently
D. Regulatory authorities penalizing insured banks
Moral hazard occurs when parties insulated from risk behave differently than they would if they were fully exposed to the risk. In banking, insured depositors may care less about how risky the bank’s investments are.
27. How does deposit insurance contribute to risky behavior by banks?
A. By limiting the interest banks can offer
B. By increasing government control over lending
C. By lowering capital requirements
D. By reducing depositor scrutiny, allowing banks to take more risks
Deposit insurance reduces the incentive for depositors to monitor banks’ behavior. Banks can exploit this by offering higher interest rates and making riskier loans to attract deposits.
28. What is one method used to reduce moral hazard in deposit insurance systems?
A. Risk-based insurance premiums
B. Increasing interest rates on deposits
C. Eliminating insurance on large accounts
D. Offering insurance only to government banks
To reduce moral hazard, deposit insurance systems can charge higher premiums to riskier banks. This encourages better risk management and discourages reckless behavior.
29. In a private placement, securities are sold:
A. Directly to qualified investors
B. Only to the general public
C. Through stock exchanges
D. To government entities only
In a private placement, securities are sold directly to a limited number of qualified investors with significant financial knowledge and resources.
30. What is a public offering in investment banking?
A. When a bank sells securities to its employees
B. When securities are issued to qualified institutions
C. When the bank purchases securities for its portfolio
D. When securities are sold to the investing public at large
A public offering involves selling securities to the general public, typically facilitated by an investment bank.
31. In a firm commitment arrangement, the investment bank:
A. Acts only as a broker
B. Purchases the entire issue and sells it to the public
C. Takes no financial risk
D. Only charges a flat fee for its services
In a firm commitment, the investment bank agrees to buy the full issue from the issuer and resell it to the public, assuming the risk if some shares remain unsold.
32. Which of the following best describes a “best efforts” arrangement?
A. The bank guarantees to buy all the securities
B. The bank sells shares only to government bodies
C. The bank tries to sell the securities but is not obligated to purchase unsold shares
D. The bank bids at auction on behalf of the issuer
In a best efforts arrangement, the investment bank markets the securities but bears no responsibility for unsold portions; the issuer bears the risk.
33. What is a Dutch auction in the context of IPO pricing?
A. Fixed price sale where all shares are sold to a single investor
B. Auction where prices increase until a buyer is found
C. Randomized pricing determined by lottery
D. Price starts high and decreases until all shares are sold at the equilibrium price
In a Dutch auction, the offering price drops until all shares are allocated. All successful bidders pay the final price, which matches supply and demand.
34. What type of conflict of interest may arise between investment banking and securities services in a bank?
A. Pressure to recommend or sell securities the bank is underwriting
B. Overdrafts in client accounts
C. Disputes over branch office hours
D. Problems with ATM reconciliations
Investment banking divisions may pressure analysts or advisors to recommend or sell securities they are trying to underwrite, leading to a conflict of interest.
35. Why is access to material nonpublic information a potential conflict in a bank?
A. It slows down trading activities
B. It causes duplication of roles
C. It can unfairly benefit other units like trading desks if shared
D. It increases the cost of loan processing
If nonpublic information obtained during banking activities is shared internally, it may give trading or investment units an unfair advantage, violating ethical and legal boundaries.
36. What was one major solution implemented by the Glass-Steagall Act in the U.S.?
A. Allowed free flow of information among banking units
B. Merged all banking functions under one department
C. Required banks to provide loans at fixed interest
D. Prohibited firms from engaging in both commercial and investment banking
The Glass-Steagall Act was designed to prevent conflicts of interest by separating commercial and investment banking activities.
37. What is a "Chinese wall" in banking regulation?
A. A firewall protecting the bank's server
B. Internal control system to prevent information sharing between departments
C. A regulatory framework for Chinese banks
D. A limit on foreign investments in Chinese markets
A Chinese wall is an internal barrier within financial institutions designed to prevent information flow between departments and avoid conflicts of interest.
38. What does the banking book primarily include?
A. Assets and liabilities related to a bank's trading activities
B. Financial instruments traded daily in the market
C. Loans and assets meant to be held to maturity
D. Market risk capital calculations
The banking book refers to assets and liabilities that are meant to be held to maturity, such as loans.
39. What is the main difference in regulatory capital calculations between the banking book and the trading book?
A. Banking book uses market risk capital calculations
B. Trading book is not considered in regulatory capital
C. Trading book uses credit risk capital calculations
D. Banking book uses credit risk capital calculations, while trading book uses market risk capital calculations
The banking book uses credit risk capital calculations, while the trading book is subject to market risk capital computations.
40. What is the default classification for a financial instrument in a bank?
A. Trading book
B. Banking book
C. Loan portfolio
D. Derivatives book
The default classification for a financial instrument in a bank is the banking book, unless the instrument is specifically traded.
41. When would a financial instrument be classified in the trading book rather than the banking book?
A. If the instrument is a loan
B. If the instrument is meant to be held to maturity
C. If a bank dedicates a desk to trade the instrument
D. If the instrument is considered a deposit
A financial instrument is classified in the trading book if the bank dedicates a desk to trade that instrument.
42. What is the key feature of the originate-to-distribute model of a bank?
A. Banks keep the loans they originate as assets
B. Banks only make loans to their own customers
C. Banks make loans and sell them to other parties
D. Banks only focus on making commercial loans
The originate-to-distribute model involves making loans and selling them to other parties rather than keeping them as assets.
43. What is a key benefit of the originate-to-distribute model?
A. It increases interest rates for consumers
B. It reduces the number of loans available in the market
C. It leads to a decrease in liquidity
D. It increases liquidity in the lending market
The key benefit of the originate-to-distribute model is that it increases liquidity in the lending market.
44. Which of the following is a drawback of the originate-to-distribute model?
A. It leads to better loan origination standards
B. It results in higher capital requirements for banks
C. It can lead to banks loosening lending standards
D. It reduces liquidity in the lending market
A drawback of the originate-to-distribute model is that it can lead to banks loosening lending standards, contributing to financial crises.
45. Which agencies in the United States are involved in purchasing mortgage loans from banks in the originate-to-distribute model?
A. Federal Reserve and U.S. Treasury
B. Ginnie Mae, Fannie Mae, and Freddie Mac
C. SEC and FDIC
D. Wall Street firms and private investors
Ginnie Mae, Fannie Mae, and Freddie Mac are the agencies that purchase mortgage loans from banks and issue securities backed by these loans.
46. The minimum level of capital a bank needs to maintain, according to its own estimates, models, and risk assessments, is best described as its
A. equity capital
B. financial capital
C. economic capital
D. regulatory capital
Economic capital refers to the minimum capital a bank needs to maintain based on its own risk assessments and models.
47. Which of the following actions in the banking system is most likely intended to address the problem of moral hazard?
A. Deposit insurers charge risk-based premiums
B. Banks increase loans to higher-risk borrowers
C. Governments implement deposit insurance programs
D. Banks increase the interest rates they offer to depositors
Charging risk-based premiums helps mitigate moral hazard by incentivizing institutions to reduce risk and avoid excessive risk-taking.
48. An investment bank is most likely to earn a trading profit from buying and selling securities if it arranges
A. a Dutch auction
B. a private placement
C. a best efforts offering
D. a firm commitment offering
A firm commitment offering allows the investment bank to buy the entire issuance and sell it to the public at a profit.
49. The purpose of a Chinese wall in banking is to
A. prevent a bank failure from endangering other banks
B. prevent a bank’s departments from sharing information
C. restrict companies from offering both banking and securities services
D. restrict companies from engaging in both commercial and investment banking
A Chinese wall is an internal control designed to prevent information flow between different departments in a bank to avoid conflicts of interest.
50. A drawback of the originate-to-distribute banking model is that it has led to
A. too little liquidity in certain sectors
B. too much liquidity in certain sectors
C. looser credit standards in certain sectors
D. tighter credit standards in certain sectors
One of the main drawbacks of the originate-to-distribute model is that it can encourage banks to loosen their credit standards, leading to increased risk.
51. Which of the following is a major risk faced by banks?
A. Environmental risk from climate change
B. Currency risk from fluctuations in exchange rates
C. Credit risk from defaults on loans or by counterparties
D. Legal risk from disputes with clients
Credit risk arises when a borrower defaults on a loan or when counterparties fail to meet their obligations.
52. What is the role of regulatory capital for banks?
A. It is a buffer for economic downturns
B. It allows banks to take excessive risks without consequences
C. It is a requirement for banks to participate in international markets
D. It ensures banks have adequate funds to cover losses from loans or trading assets
Regulatory capital is required to mitigate the risks of bank failures due to losses on loans or trading assets.
53. What is the difference between regulatory capital and economic capital?
A. Regulatory capital is the amount required by regulators, while economic capital is the amount based on a bank's own models
B. Regulatory capital is based on a bank’s performance, while economic capital is an arbitrary figure
C. Economic capital is the capital available to regulators, while regulatory capital is held by the bank
D. Economic capital refers to the capital requirements for trading activities only
Regulatory capital is defined by regulators, while economic capital is determined by banks using their own risk models.
54. What is the moral hazard caused by deposit insurance?
A. It encourages banks to minimize their operational risk
B. It leads to increased risk-taking by banks as depositors are insured
C. It forces banks to raise interest rates for deposits
D. It reduces competition among banks
Deposit insurance reduces depositors' incentive to monitor the health of banks, leading to higher risk-taking by the banks.
55. What is the difference between a private placement and a public offering?
A. A private placement is restricted to a small number of investors, while a public offering is available to the general public
B. A private placement involves government bonds, while a public offering involves stocks
C. A private placement sells directly to qualified investors, while a public offering sells to the public
D. A private placement is risk-free, while a public offering carries high risk
In a private placement, securities are sold directly to qualified investors, while in a public offering, securities are sold to the public.
56. What is the potential conflict of interest in a bank offering commercial banking, investment banking, and securities services?
A. Investment banks may have an unfair advantage in trading based on information gained from commercial banking transactions
B. Commercial banking operations are not affected by securities services
C. Securities services are always independent of investment banking activities
D. Investment banking leads to conflicts only in stock trading
Conflicts may arise when information acquired in one banking unit gives another unit an unfair advantage, as in investment banking and securities services.
57. What is the main difference between the banking book and the trading book?
A. The banking book consists of long-term securities, while the trading book contains short-term securities
B. The banking book deals with corporate clients, while the trading book deals with retail clients
C. The banking book has no regulatory capital requirements, while the trading book has higher requirements
D. The banking book consists of assets held to maturity, while the trading book consists of assets related to trading activities
The banking book contains assets held to maturity, such as loans, while the trading book contains assets used for trading, like stocks.
58. What does the originate-to-distribute model in banking involve?
A. Banks sell loans to other parties, freeing up capital and increasing liquidity, but it may lower lending standards
B. Banks retain loans on their balance sheet until maturity
C. Banks issue bonds to fund loans
D. Banks only lend to high-creditworthy borrowers
The originate-to-distribute model involves making loans and selling them to other parties, which frees up capital for further lending.
