ADVANCED CREDIT RISK MANAGEMENT APRIL 2022 PAST PAPER

MONDAY: 4 April 2022.  Afternoon paper.                                                                                               Time Allowed: 3 hours.

Answer ALL questions.  Marks allocated to each question are shown at the end of the question.  Do NOT write anything on this paper.

QUESTION ONE

MUTUA BROTHERS LTD. AND AKILI BANK

It was a troublesome morning for the Mutua’s family and Akili Bank, the directors of Mutua Brothers Ltd. They were scratching their heads, attempting to come to conclusion, and blaming one of the well-established banks in the regional market, Akili Bank.  The Mutua’s had been jointly issued with a pre-sanction letter in the names of both the brothers, John Mutua and James Mutua, from Akili Bank.  On the basis of the pre-sanction letter being issued to the Mutua’s jointly, it included the home loan pertaining to the property they had finalised at Lavington Green.

The pre-sanction letter provided approval for the amount of Sh.50 million, a loan based upon consideration of the financial strength of both brothers, on submission of the required documents.  The property deal was finalised at Sh.48 million that is within the approval limit being sanctioned to them.  When they approached the bank to issue the sanction letter and subsequent disbursement of the loan amount, they were surprised to discover from bank officials that, in normal circumstances, Akili Bank does not disburse home loans to two brothers in joint names.  The Mutua’s were taken aback by this response, which caused them to engage in a verbal exchange with the bank’s officials.  Their main point of contention was that the bank officials had “issued a pre-sanction jointly in the name of both the brothers”.  To that end, an enquiry was carried out into whether it was communicated to them that the loan could not be disbursed jointly in both of their names. Of course, the brothers’ contention was that they would have approached other banks if they had been made aware of the bank’s stance.

The Mutua’s visited Akili Bank on a later date where they met with Duncan Wanyama, the head of the branch, and provided him with the pre-sanction letter with which they had earlier been issued.  Duncan Wanyama discussed the issue with his colleague and finally assured them that they would seek approval from their boss, Judy Mwangi, and would communicate her response to them in two days.  Duncan Wanyama also conceded that it was the bank’s mistake to issue the pre-sanction letter in joint names.  The grievance was further exacerbated when Duncan Wanyama informed the Mutua’s that they would have to submit Life Insurance Cover policies to the tune of Sh.5million as additional collateral security, since the loan was in the joint names of both brothers.  Although they were not informed about this at the time of seeking pre-sanction approval, they nonetheless extended their full cooperation to the bank and provided them with the Life Insurance Cover policies of John Mutua and James Mutua to the extent of Sh.2.5million each.

Nevertheless, the issues did not end there.  Rather, the Mutua’s were then told that they would need to provide the bank with the surrender value of the policies.  However, as the policies had not yet been issued for three years, the Mutua’s did not yet have their surrender value.  Again, the Mutua’s were assured by Duncan Wanyama that he would try to address their problem with higher authorities, to waive the three-year period for subsequent approvals.  In short, although the Mutua’s had wholeheartedly extended their cooperation to the bank to expedite the process of disbursement of a home loan, they did not receive the sanction letter and had to forgo the property deal, resulting in them suffering a huge financial loss; their future investment and other activities depended a lot on their ability to close the deal and, the owner of the property was not willing to co-operate with them.

 

Required:

1.          From the above case study, summarise three factors that determine home loan application sanctioning. (6 marks)

2.          Explain the following terms as used in the case:

Loan pre-sanctioning letter.                                                                                                                          (2 marks)

Surrender value.                                                                                                                                              (2 marks)

3.          With reference to Akili Bank’s case, explain two benefits of pre-sanctioned home loan.                               (4 marks)

4.          Summarise six documents required from Mutua Brothers Ltd. for home loan sanctioning.                           (6 marks)

5.          Describe the term “Lender Liability Risk”.                                                                                                (2 marks)

Discuss three techniques Akili Bank should have used to reduce Lender Liability Risk.                 (6 marks)

6.          Assess three project risks that Mutua Brothers Ltd. could suffer.                                                                         (6 marks)

7.          Discuss three benefits of using life insurance cover policy as an additional collateral to Mutua Brothers Ltd. brothers.   (6 marks)

(Total: 40 marks)

 

QUESTION TWO

1.          Discuss three factors that a bank’s regulator should take into consideration when examining the working capital loan portfolio of a microfinance bank.                                                                                                                      (6 marks)

2.         Discuss three effects of a severe financial crisis in the financial sector.                                                              (6 marks)

3.         Explain Moody’s KMV Credit Portfolio model.                                                                                                       (3 marks)

(Total: 15 marks)

 

QUESTION THREE

1.          Describe the term “Risk Adjusted Return on Capital (RAROC)”.                                                        (2 marks)

Analyse three purposes of undertaking RAROC assessment.                                                               (6 marks)

2.          Explain two criteria used by banks to effectively monitor and manage collateral to mitigate against liquidity risk that may occur within the day while trading.                                                                                                            (4 marks)

3.          List three parties who are responsible for ensuring that a microfinance bank maintains adequate provisionary for its loan portfolio.                                                                                                                                                            (3 marks)

(Total: 15 marks)

 

QUESTION FOUR

1.         A credit derivative is one in which the risk that a loan will not be repaid is sold to a party other than the lender.

With reference to the above statement:

Enumerate four risks of credit derivatives.                                                                                                (8 marks)

Examine four characteristics of transactions that generate dynamic credit exposures.                   (3 marks)

2.          Summarise four impacts of inflation on working capital.                                                                                      (4 marks)

(Total: 15 marks)

 

QUESTION FIVE

1.         Describe four approaches used to measure the probability of default on loan.                                                   (4 marks)

2.        Outline six factors that influence interest rate charged on instalment loans by banks.                                      (6 marks)

3.        State five terms and conditions that are included by lenders in project finance loans’ contracts.                   (5 marks)

(Total: 15 marks)

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