Question 1
From the 2016 annual reports of The Commonwealth Bank of Australia (CBA) and Westpac, we can obtain the following information regarding home loans:
CBA has a stock of home loans valued at $409,452 million with total provisions for non-performing loans of $193 million.On the other hand, Westpac holds home loans valued at a total of $418,729 with total provisions of $57 million. Use this information to answer the following:
a. Australians prefer variable rate mortgages. In fact, only about 12-15% of all home loans have been fixed in the last 25 years. Given what we know about the future direction interest rates in Australia, and assuming other factors between CBA and Westpac are the same, which bank do you think has originated more variable rate loans? Explain your answer.
b. Is duration matching a more effective method for controlling interest rate risk for the CBA or for Westpac? Explain your answer.
c. Suppose that interest rates change via parallel shifts in the yield curve. In addition to matching the duration of assets with the (leverage adjusted) duration of liabilities, what other measures must these two banks take to minimise interest rate risk exposure? Are these additional steps more challenging for CBA or Westpac? Explain your answer.

Question 2
Recall from class that the FICO scoring system is the most widely used credit risk scoring system in the US for retail lending. Typically, higher FICO scores are associated with lower credit risk and result in better borrowing terms for the customer. Read Exhibit 1 “Will change to credit reports change how banks vet borrowers” and answer the following questions.
a. Do you think that this change is a good idea? Explain your answer.
b. Will this change result in an increase or decrease in average FICO scores? Explain your answer.
c. Holding other factors constant, in the context of the RAROC model, do you think that more loans will be approved after this change? Explain your answer.
d. Given your answers above, has credit risk increased or decreased? Explain your answer.
e. If you are operating a bank without capacity to build and update your own credit risk model (and thus reliant on the FICO system), how would you update your loan underwriting (i.e. screening and pricing) to reflect this change?
f. Given your answer in (e), in the context of the RAROC model, what changes will you make, if any, to the parameters in the model? Explain the answer.

Question 1 From the 2016 annual reports of The Commonwealth Bank...