Econ 330 Exam 2
Federal deposit insurance covers deposits up to $250,000, but as part of a doctrine called "too−big−to−fail" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the FDIC does this, it uses the
"purchase and assumption" method.
A bank almost always insists that the firms it lends to keep compensating balances at the bank. Why?
1) Compensating balances help establish long-term customer relationships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem 2) Compensating balances can act as collateral 3) Compensating balances help the bank monitor the activities of a borrowing firm, which reduces the moral hazard problem
Rank the following bank assets from most liquid to least liquid . (Enter a numerical value between 1 and 4.)
1) Reserves 2)Securities 3)Commercial loans 4)Physical capital
In recent years the interest paid on checkable and nontransaction deposits has accounted for around ________ of total bank operating expenses, while the costs involved in servicing accounts have been approximately ________ of operating expenses.
25 percent; 50 percent
Which of the following is likely a result of increased interest-rate volatility?
An increase in demand for financial services and products
Which of the following statements are true?
A bank's balance sheet shows that total assets equal total liabilities plus equity capital.
At the height of the global financial crisis in October 2008, the U.S. Treasury forced nine of the largest U.S. banks to accept capital injections, in exchange for nonvoting ownership stock, even though some of the banks did not need the capital and did not want to participate. What could be the rationale for doing this?
By forcing all banks to accept capital injections, it would help prevent bank runs on the weakest banks.
________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow.
Calling in loans
Which of the following are reported as liabilities on a bank's balance sheet?
Checkable deposits
Which of the following are transaction deposits?
Checkable deposits
Which of the following is not an asset on a bank's balance sheet?
Checkable deposits
Which of the following statements are true?
Checkable deposits are payable on demand.
Why were consumer protection provisions included in the Dodd-Frank bill, a bill designed to strengthen the financial system?
Consumer protection will avert future financial problems in the housing market.
What are the five areas included in the Dodd-Frank Act of 2010?
Consumer protection, resolution authority, systemic risk regulation, Volcker rule, and derivatives.
If casualty insurance companies provided fire insurance without any restrictions, what kind of moral hazard problem might result?
Customers would take less preventive care in avoiding fire risk with this type of insurance
"Because diversification is a desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans." Is this statement true or false? Explain your answer.
False. A bank may have developed expertise in screening and monitoring a particular type of loan, thus improving its ability to handle problems of adverse selection and moral hazard.
________ is the process of researching and developing new instruments to address the needs of investors and institutions in a rapidly changing financial climate.
Financial engineering
If a bank doubles the amount of its capital and ROA stays constant, what will happen to ROE?
Given the ROA, if bank capital doubles, then ROE will fall by half.
Which of the following has not resulted from more active liability management on the part of banks?
Increased bank holdings of cash items
Which agency has regulatory responsibility when a bank operates in many different countries?
It is not always clear.
Which of the following is a main responsibility of the bank manager?
Maintaining reserves at a level to minimize the cost to the bank of deposit outflows.
Which of the following are primary concerns of the bank manager?
Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows
Which of the following may not be used as a backup line of credit?
Mortgages
If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down, explaining that you don't have any excess reserves to lend out? Why or why not? What options are available for you to provide the funds your customer needs?
No. There are several ways that reserves can be acquired. For example, the bank can borrow at the discount window or in the federal funds market, or it can acquire funds by issuing negotiable CDs.
How can the S&L crisis be blamed on the principal-agent problem? As a result, politicians and regulators __________________________, thereby increasing the cost of the S&L bailout.
Politicians and regulators, who are known as the agents, have not had the same incentives to minimize costs of deposit insurance as do the taxpayers, who are known as the principals relaxed capital standards, removed restrictions on holdings of risky assets, and engaged in regulatory forbearance
Which of the following are reported as assets on a bank's balance sheet?
Reserves
Which of the following bank assets is the most liquid?
Reserves
Why is it important for the U.S. government to have resolution authority?
Resolution authority allows the government to quickly takeover a failing firm.
How could higher deposit insurance premiums for banks with riskier assets benefit the economy?
Risk-based premiums would help mitigate the moral hazard problem; however, it is difficult to monitor the degree of risk in bank assets because often only the bank making the loans knows how risky they are
Why has the trend in bank supervision moved away from a focus on capital requirements to a focus on risk management?
Since capital requirements do not effectively indicate whether banks are taking on too much risk, risk management allows supervisors to focus more on risk-taking procedures and thus may prevent insolvency in the future.
A bank finds that its ROE is too low because it has too much bank capital. Which of the following will not raise its ROE?
The bank can sell part of its holdings of securities and hold more excess reserves
If you are a banker and expect interest rates to rise in the future, would you want to make short-term or long-term loans?
You would want to make short-term loans so you can reinvest the funds at higher interest rates after their maturity.
A bank failure is less likely to occur when
a bank has more bank capital.
A reason why rogue traders have bankrupt their banks is due to
a failure to maintain proper internal controls
Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans.
adverse selection
If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment projects, banks are said to face the problem of:
adverse selection
In order to reduce the ________ problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones.
adverse selection
When bad drivers line up to purchase collision insurance, automobile insurers are subject to the
adverse selection problem.
Collateral requirements lessen the consequences of ________ because the collateral reduces the lender's losses in the case of a loan default and it reduces ________ because the borrower has more to lose from a default.
adverse selection; moral hazard
The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem.
adverse selection; moral hazard
If a bank's liabilities are more sensitive to interest rate movements than are its assets, then
an increase in interest rates will reduce bank profits.
All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ________ in interest rates will ________ bank profits.
an increase; reduce
The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance
are likely to take on greater risks than they otherwise would.
Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called
basic gap analysis.
If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could
borrow from another bank in the federal funds market.
Regulations that reduced competition between banks included
branching restrictions.
Because of an expected rise in interest rates in the future, a banker will likely
buy short−term rather than long−term bonds.
Banks earn profits from off−balance sheet loan sales
by selling existing loans for more than the original loan amount.
The leverage ratio is the ratio of a bank's
capital divided by its total assets.
Holding all else constant, when a bank receives the funds for a deposited check,
cash items in the process of collection fall by the amount of the check.
Suppose $200,000 is deposited at a bank. The required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead. What are the bank's total reserves?
chapter 9-10 problem # 3; Total reserves are $40,000
During the boom years of the 1920s, bank failures were quite
common, averaging about 600 per year.
The principal−agent problem that exists for bank trading activities can be reduced through
creation of internal controls that separate trading activities from bookkeeping.
When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in
credit rationing.
If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in
deposits and reserves.
A main provision of the Competitive Equality in Banking Act (CEBA) of 1987 included:
directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance.
Regulations designed to provide information to the marketplace so that investors can make informed decisions are called
disclosure requirements.
Bank loans from the Federal Reserve are called ________ and represent a ________ of funds.
discount loans; source
From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem
diversification; adverse selection
The amount of assets per dollar of equity capital is called the
equity multiplier.
Banks that suffered significant losses in the 1980s made the mistake of
failing to diversify their loan portfolio.
The difference of rate−sensitive liabilities and rate−sensitive assets is known as the
gap.
Firms that are designated as systemically important financial institutions (SIFIs) are subject to all of the following additional Federal Reserve regulations except
interest rate ceilings on time deposits.
Risk that is related to the uncertainty about interest rate movements is called
interest−rate risk.
A bank is insolvent when
its liabilities exceed its assets.
The Depository Institutions Deregulation and Monetary Control Act of 1980:
led to the creation of NOW accounts nationwide.
Regulators attempt to reduce the riskiness of banks' asset portfolios by
limiting the amount of loans in particular categories or to individual borrowers.
Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Fed, and borrowings from other banks to deal with deposit outflows is an example of
liquidity management.
A bank's commitment to provide a firm with loans up to pre−specified limit at an interest rate that is tied to a market interest rate is called
loan commitment.
When Jane Brown writes a $100 check to her nephew, and he cashes the check, Ms. Brown's bank ________ assets of $100 and ________ liabilities of $100
loses; loses
With ________, firms value assets on their balance sheet at what they would sell for in the market.
mark−to−market accounting
In order to reduce the ________ problem in loan markets, banks often insist on collateral from potential borrowers.
moral hazard
Which of the following is not an example of a backup line of credit?
mortgages
The practice of keeping high−risk assets on a bank's books while removing low−risk assets with the same capital requirement is know as
regulatory arbitrage.
Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called
restrictive covenants.
Net profit after taxes per dollar of assets is a basic measure of bank profitability called
return on assets.
The Basel Accord, an international agreement, requires banks to hold capital based on
risk−weighted assets.
Banks acquire the funds that they use to purchase income−earning assets from such sources as
savings accounts.
Because ________ are less liquid for the depositor than ________, they earn higher interest rates.
savings accounts; checkable deposits
Examples of off-balance-sheet activities include:
selling loan portfolios
If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can
sell $3 million of securities.
Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the bank's assets to increase their rate sensitivity or, alternatively, ________ the duration of the bank's liabilities.
shortening; lengthening
Secondary reserves include
short−term U.S. government securities.
The share of checkable deposits in total bank liabilities has
shrunk over time.
The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is
that the FDIC guarantees all deposits when it uses the "purchase and assumption" method.
Agreements such as ________ are attempts to standardize international banking regulations.
the Basel Accord
The new Consumer Financial Protection Bureau is an independent agency but is funded and housed within
the Federal Reserve.
When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the bank's final balance sheet,
the liabilities of the bank increase by $1,000,000.
In the absence of regulation, banks would probably hold
too little capital.
Examples of off−balance−sheet activities include
trading activities.
The Volcker Rule addresses the off−balance−sheet problem involving
trading risks.
The largest percentage of banks' holdings of securities consist of
treasury and government agency securities.
In order to ensure that borrowers have an ability to repay residential mortgages, the new consumer protection legislation requires lenders to do all of the following except
verify that the borrower can read and understand a loan contract.
In May 1991, the FDIC announced that it would sell the government's final 26% stake in Continental Illinois, ending government ownership of the bank that it had rescued in 1984. The FDIC took control of the bank, rather than liquidate it, because it believed that Continental Illinois
was too big to fail.
As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________.
increase; increase
When a new depositor opens a checking account at the First National Bank, the bank's assets ________ and its liabilities ________.
increase; increase
Risk that is related to the uncertainty about future interest-rate movements is called:
interest-rate risk
Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy ________ with a different set of characteristics.
liabilities; assets
Banks generate profits by earning higher returns on their ____________ than they pay in interest on _____________.
loans; deposits
Large-denomination CDs are ________, so that like a bond, they have a ________degree of liquidity and can be sold in secondary markets.
negotiable; greater