Learning Objectives: Analyze the credit risks and other risks generated by retail banking. Explain the differences between retail credit risk and corporate credit risk. Discuss the “dark side” of retail credit risk and the measures that attempt to address the problem.
Questions:
25.5.1. BrightBank is a mid-sized retail bank with a strong presence in personal lending. As of Q1 20X5, its retail portfolio includes:
The credit risk team has observed the following:
Based on the above information, identify which of the following statements is LEAST accurate?
a. Borrowers prioritize home loan repayments over unsecured debt, indicating an asymmetric risk profile.
b. Economy-wide factors are likely to impact all borrower categories simultaneously.
c. Increased HELOC utilization implies borrowers are using available credit to manage cash flow gaps.
d. Rising defaults across the portfolio due to macroeconomic stress rather than borrower-specific issues indicate a high concentration risk.
25.5.2. Silver Lining Bank maintains the following portfolios:
Recent economic data indicates the following:
Which of the following is the LEAST accurate?
a. Retail credit risk involves lower individual exposure per default and is highly diversified, reducing concentration risk, whereas corporate risk involves higher per-borrower exposure and significant sector concentration.
b. Corporate defaults increase sharply during downturns due to concentrated exposure, larger loan sizes, and corporate reliance on credit lines, while retail defaults rise moderately because of smaller loans and diversified borrower behavior.
c. Concentration risk is notably higher in corporate lending due to fewer large loans and sector-specific vulnerabilities; in contrast, retail lending’s diversification across many smaller loans reduces concentration and systemic exposure.
d. Retail and corporate credit risks have comparable risk profiles and default patterns during economic downturns.
25.5.3. New Horizon Credit, a retail-focused lender, provides small consumer loans across varied regions and income tiers. Despite portfolio diversification, the lender observed widespread increases in defaults. Internal diagnostics revealed:
a. Macroeconomic stress invalidates diversification assumptions in retail portfolios by inducing correlated borrower behavior.
b. Retail loan default modeling remains robust under systemic stress, given high borrower granularity.
c. Borrowers adapt rationally to loan restructuring when default incentives increase, mitigating default probabilities.
d. Automated retail credit scoring reduces model risk through its consistent application of risk factors.
Answers here:
Questions:
25.5.1. BrightBank is a mid-sized retail bank with a strong presence in personal lending. As of Q1 20X5, its retail portfolio includes:
- $1 billion in fixed-rate and adjustable-rate mortgages
- $300 million in home equity loans and HELOCs
- $500 million in unsecured credit card balances
- $150 million in personal installment loans (some secured against home equity)
The credit risk team has observed the following:
- Delinquency rates on credit cards have increased by 1.2% in the past quarter.
- Requests for loan restructuring on home equity loans have risen 15% year-over-year.
- A sharp rise in early withdrawals from HELOCs
Based on the above information, identify which of the following statements is LEAST accurate?
a. Borrowers prioritize home loan repayments over unsecured debt, indicating an asymmetric risk profile.
b. Economy-wide factors are likely to impact all borrower categories simultaneously.
c. Increased HELOC utilization implies borrowers are using available credit to manage cash flow gaps.
d. Rising defaults across the portfolio due to macroeconomic stress rather than borrower-specific issues indicate a high concentration risk.
25.5.2. Silver Lining Bank maintains the following portfolios:
Recent economic data indicates the following:
- A significant increase in unemployment from 4% to 8%
- Decline in real estate prices by 5%
- Central indicated that it would reduce its balance sheet by selling risky assets.
Which of the following is the LEAST accurate?
a. Retail credit risk involves lower individual exposure per default and is highly diversified, reducing concentration risk, whereas corporate risk involves higher per-borrower exposure and significant sector concentration.
b. Corporate defaults increase sharply during downturns due to concentrated exposure, larger loan sizes, and corporate reliance on credit lines, while retail defaults rise moderately because of smaller loans and diversified borrower behavior.
c. Concentration risk is notably higher in corporate lending due to fewer large loans and sector-specific vulnerabilities; in contrast, retail lending’s diversification across many smaller loans reduces concentration and systemic exposure.
d. Retail and corporate credit risks have comparable risk profiles and default patterns during economic downturns.
25.5.3. New Horizon Credit, a retail-focused lender, provides small consumer loans across varied regions and income tiers. Despite portfolio diversification, the lender observed widespread increases in defaults. Internal diagnostics revealed:
- The credit model failed to capture rising correlations across borrower segments during macroeconomic stress.
- Herd-like behavior emerged, including preemptive defaults driven by liquidity concerns.
- Complex restructuring terms alienated distressed borrowers, leading to procedural or frustration-driven defaults.
a. Macroeconomic stress invalidates diversification assumptions in retail portfolios by inducing correlated borrower behavior.
b. Retail loan default modeling remains robust under systemic stress, given high borrower granularity.
c. Borrowers adapt rationally to loan restructuring when default incentives increase, mitigating default probabilities.
d. Automated retail credit scoring reduces model risk through its consistent application of risk factors.
Answers here:
