Question

1. How do loan portfolio risks differ from individual loan risks? What is the importance of concentration limits in managing the amount of NPLs (non-performing loans)?

2. Explain whether each of the statements below is True, False or Uncertain. Justify your answer.

a. Compensating balances kept at the bank that has originated a loan help to reduce the adverse selection and moral hazard problems associated with lending.

b. If the book value of the collateral is greater than or equal to the amount of the loan, the credit risk of the lender is fully covered.

c. The market risk premium positively depends on the probability of default of the borrower and the recovery rate.

Answer 1

question 1:-
Answer:- Individual loan risks are greater because that particular individual will be sujec to more risk and his all assets are covered in obligations and bank can overtake all his assets to over come the same
at the same time in portpolio load risks only associated things can be over taken ,perosnal assets cannot to taken by bank in case of default.

question 2:-
answer
a.True. by conpensating the same we reduce our risk expolure hence it will reduce our obligations
b.True credit risk of lender is referred to as if total complete company is liquiadated then whether complete paymentof loan will be made or not, in case book value> loan than we can recover.
c.True as defaultof borrower increase means lender is exposed to more risk hence market risk premium will be relatively higher .