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    The 5 C's of Credit, RAROC System, Too Big to Fail Policy.

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    1. List the 5 C's of credit and explain the monitoring function of a bank and discuss the differences between soft & hard information and the role they play in identifying the impact of information asymmetry.
    Explain relationship lending and how lending can be different between traditional banks, private equity and venture capital firms. Illustrate by graph how the competitive advantage of a bank is generated as its attempts to design portfolios that generate abnormal returns?

    2. What is the relationship between the probability of default and the proportion of principal and interest that may be recovered in the case of default on the loan?

    3. List the 3 factors that determine the expected loss under a RAROC system? How is RAROC different from ROE?

    4. What is meant by To Big To Fail regulatory policy under the Dodd Frank Wall Street Reform and Consumer Protection Act. Who are the major regulatory agencies and branches of government that are associated with the To Big To Fail policy. How do the regulatory agencies and branches of government involved in To Big To Fail policy resolve systemic consequences?

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    Solution Preview

    1. The five Cs of credit are character, capacity, capital, collateral, and conditions. This is a mix of hard and soft factors. The hard factors are quantitative in nature and the soft factors are qualitative. For example, the capital or the amount that the borrower puts forward is a hard factor. Similarly, the collateral that the borrower puts forward is a hard factor. The character or the reputation of the borrower is a soft factor. The monitoring function of bank is that it receives periodic reports from the lender, studies the hard information and assesses if the lender has maintained its ability to repay the loan. There is information asymmetry because the borrower has more information about his credit standing, including his financial condition. The bank by monitoring the activities of the lender reduces this information asymmetry. Relationship banking means engaging in multiple interactions with borrowers through multiple products over time and invests in getting costly, proprietary information on borrowers that remain confidential. Relationship banking requires continual, personalized direct contact with borrowers in the local community in which they operate. Traditional banks have little continual contact with borrowers, private equity usually leads to leveraged buyout and the ...

    Solution Summary

    The answer to this problem explains the financial system and its problems. The references related to the answer are also included.