Explanation:
Unexpected loss is a measure of the variation in expected loss. As a precaution, the bank needs to set aside sufficient capital in the event that actual losses exceed expected losses with a reasonable likelihood. For example, smaller recovery rates would be indicative of larger actual losses.
(Book 4, Module 52.1, LO 52.d)
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Question 30
Bank regulators are examining the loan portfolio of a large, diversified lender. The regulators' main concern is that the bank remains solvent during turbulent economic times. Which of the following statements is most likely the area on which the regulators will want to focus?
A
Expected loss, since each asset can expect, on average, to decline in value from a positive probability of default.
B
Expected loss, given the decrease in underwriting standards of new loans.
C
Unexpected loss, since the bank will need to set aside additional capital for the unlikely event that recovery rates are smaller than expected.
D
Unexpected loss, since the bank will need to set aside additional capital for the unlikely event that loss rates are smaller than expected.
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