ADVANCED CREDIT RISK MANAGEMENT DECEMBER 2022 PAST PAPER

MONDAY: 5 December 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

WAKUMAT BROTHERS HOLDINGS (WBH)

On September 15, 2008, Wakumat Brothers Holdings (WBH), sought protection under the Insolvency and Bankruptcy
Act, initiating the largest bankruptcy proceeding in the history of the country. The company declared Sh.60 billion in
assets and Sh.55 billion in debts. At the time, WBH was the fourth-largest investment bank, with 2,500 employees in
East Africa, a far cry from its humble beginnings in 1984, as an ordinary warehouse. Despite being thought “too big to
fail,” the government did not employ extraordinary measures to save the company.

WBHs’ demise was the beginning of a major event in the financial crisis that began in the country’s mortgage industry in
2007, spread to the credit markets, and then burned through the region’s financial markets. The crisis resulted in significant and wide losses to the economy. Estimates of the cost to the economy based on lost output range from a few billion shillings to over Sh.100 billion. And this is despite the unprecedented efforts of the Central Bank, the National Treasury, the Deposit Protection Fund and the central banks of the regional countries to intervene and stabilise their economies.

The 2008 financial crisis began with cheap credit and lax lending standards that fuelled a real estate bubble. When the
bubble burst, the banks were left holding billions of shillings of worthless investments in mortgages. The Great
Economic recession that followed cost many their jobs, their savings, and their homes. One cause of WBH’s demise was
its significant exposure to the mortgage and real estate markets. When these markets began to slow down, they sparked a
retraction in the “shadow banking system” for short-term loans as concerns about unknown exposures to securitized
mortgages spread to other types of assets.

WBH’s collapse had far reaching implications. Investor sentiment became nervous resulting in sharp falls in stock
markets, triggering a flight to safety. If one of the top five investment banks is not safe, who is safe? It resulted in the
disappearance of pure investment banking. WBH, like most investment banks, relied on short-term markets to raise millions of shillings each day. Ultimately, it was an inability to secure funding that was WBH’s undoing.

Required:

1. One cause of WBH’s demise was its significant exposure to the mortgage and real estate markets. With reference to the above statement, state FOUR additional factors which could have contributed to the collapse of WBH. (4 marks)

2. The Great Economic recession that followed cost many people their jobs, their savings, and their homes.

Required:

With reference the above statement:

Describe the term “economic recession”. (2 marks)

Explain FOUR factors that could have caused the economic recession. (8 marks)

3. Housing bubbles are temporary periods characterised by high demand, low supply and prices that are inflated beyond fundamentals as demonstrated in the case of WBH.

With reference to the above statement:

Summarise SIX factors that could cause an increase in the demand for housing. (6 marks)

4.  Despite being thought “too big to fail,” the government did not employ extraordinary measures to save WBH.

Required:

With reference to the above statement: (2 marks)

Describe your understanding of “too big to fail”. (2 marks)

Summarise FOUR policy measures that government’s put in place after the year 2008 financial crisis to avoid the collapse of the “too big to fail” companies in future. (8 marks)

5. Discuss FIVE consequences of the credit crisis as a result of the collapse of WBH. (10 marks)

(Total: 40 marks)

QUESTION TWO

1. Describe the term “portfolio analysis”. (2 marks)

Distinguish between “passive credit portfolio” and “active credit portfolio” management. (4 marks)

2. State FOUR components that banks should factor in while pricing loans. (4 marks)

3. Outline FIVE qualities of a good collateral asset. (5 marks)

(Total: 15 marks)

QUESTION THREE

1. Enumerate FOUR goals of the Basel II Accord. (4 marks)

2. State FIVE indicators of an organisation’s good risk culture. (5 marks)

3. Summarise THREE variables used in calculating net present value (NPV). (6 marks)

(Total: 15 marks)

QUESTION FOUR

1. Describe the term “enterprise-wide stress testing”. (3 marks)

Justify TWO reasons why banks apply enterprise-wide stress testing in credit risk management. (4 marks)

2. Differentiate between “credit risk culture” and “credit risk appetite”. (4 marks)

Describe TWO factors that a credit manager should consider when categorising an organisation’s credit risk appetite. (4 marks)

(Total: 15 marks)

QUESTION FIVE

1. Enumerate THREE weaknesses of credit insurance as a credit risk mitigant. (3 marks)

2. Describe THREE types of concentration risks. (6 marks)

3. Examine THREE types of risks during the construction phase of a project. (6 marks)

(Total: 15 marks)

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