ECON 206 Chapter 10
" "17) Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth. A) call reports B) balance reports C) regulatory sheets D) examiner updates
Answer: A
" "17) China is trying to move its banking system from being strictly ________ owned by having them issue shares overseas. A) state B) domestic investor C) depositor D) domestic corporate
Answer: A
" "17) The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry. A) an adverse selection B) a moral hazard C) a lemons D) a revenue
Answer: A
" "12) As in the United States, an important factor in the banking crises in Latin America was the ________. A) financial liberalization that occurred in the 1980s B) decline in real interest rates that occurred in the 1980s C) high inflation that occurred in the 1980s D) sluggish economic growth that occurred in the 1980s
Answer: A
" "10) When regulators chose to allow insolvent S&Ls to continue to operate rather than to close them, they were pursuing a policy of ________. A) regulatory forbearance B) regulatory kindness C) ostrich reasoning D) ignorance reasoning
Answer: A
" "11) According to CDIC risk profiles, ________. A) group 1 is the best and group 4 is the worst B) group 4 is the best and group 1 is the worst C) all banks are considered to be similar D) there is no way to distinguish between them
Answer: A
" "11) The policy of ________ exacerbated ________ problems as savings and loans took on increasingly huge levels of risk on the slim chance of returning to solvency. A) regulatory forbearance; moral hazard B) regulatory forbearance; adverse hazard C) regulatory agnosticism; moral hazard D) regulatory agnosticism; adverse hazard
Answer: A
" "11) When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of ________. A) moral hazard B) split incentives C) ex ante shirking D) pre-contractual opportunism
Answer: A
" "10) Banks engage in regulatory arbitrage by ________. A) keeping high-risk assets on their books while removing low-risk assets with the same capital requirement B) keeping low-risk assets on their books while removing high-risk assets with the same capital requirement C) hiding risky assets from regulators D) buying risky assets from arbitragers
Answer: A
" "10) Deposit insurance has not worked well in countries with ________. A) a weak institutional environment B) strong supervision and regulation C) a tradition of the rule of law D) few opportunities for corruption
Answer: A
" "12) Moral hazard is an important concern of insurance arrangements because the existence of insurance ________. A) provides increased incentives for risk taking B) is a hindrance to efficient risk taking C) causes the private cost of the insured activity to increase D) creates an adverse selection problem
Answer: A
" "12) Overseeing who operates banks and how they are operated is called ________. A) prudential supervision B) hazard insurance C) regulatory interference D) loan loss reserves
Answer: A
" "13) Banking reform possibilities include ________. A) coinsurance B) bank mergers C) reduced capitalization requirements D) reducing the scope of deposit insurance
Answer: A
" "13) FDICIA ________ incentives for banks to hold capital and ________ incentives to take on excessive risk. A) increased; decreased B) increased; increased C) decreased; decreased D) decreased; increased
Answer: A
" "14) Deposit co-insurance requires that ________. A) only a percentage of a deposit would be covered by insurance B) the amount of deposits covered by insurance would be lowered C) there be joint insurance from both bankers and depositors D) both the federal and provincial governments provide deposit insurance
Answer: A
" "14) Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions except ________. A) forgiving tax debt B) lending from the central bank C) lending directly from the government's treasury department D) nationalizing and guaranteeing that all creditors will be repaid their loans in full
Answer: A
" "14) The chartering process is similar to ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets. A) screening; restrictive covenants B) screening; branching restrictions C) identifying; branching restrictions D) identifying; credit rationing
Answer: A
" "15) Although the CDIC was created to prevent bank failures, its existence encourages banks to ________. A) take too much risk B) hold too much capital C) open too many branches D) buy too much stock
Answer: A
" "15) The MacKay Task Force may recommend that the ________. A) OFSI and CDIC be amalgamated B) CDIC be abolished C) Standards of Sound Business Practices be implemented D) OFSI and CDIC should be separated
Answer: A
" "15) When comparing the banking crisis in the United States to the crises in Latin America, cost to the taxpayers of the government bailouts was ________. A) higher in Latin American than in the United States B) higher in the United States than in Latin America C) about the same in both Latin America and the United States D) positive in Latin America but negative in the United States
Answer: A
" "16) A system of deposit insurance ________. A) attracts risk-taking entrepreneurs into the banking industry B) encourages bank managers to decrease risk C) increases the incentives of depositors to monitor the riskiness of their bank's asset portfolio D) increases the likelihood of bank runs
Answer: A
" "16) Bank examiners include ________. A) the Bank of Canada B) Canada Revenue Agency C) the OSC D) the Department of Finance
Answer: A
" "16) The Japanese banking system went through a cycle of ________ in the 1990s similar to the one that occurred in the U.S. in the 1980s. A) regulatory forbearance B) policy antagonism C) regulatory ignorance D) policy renewal
Answer: A
" "19) The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance ________. A) are likely to take on greater risks than they otherwise would B) are likely to be too conservative, reducing the probability of turning a profit C) are likely to regard deposits as an unattractive source of funds due to depositors' demands for safety D) are placed at a competitive disadvantage in acquiring funds
Answer: A
" "2) One of the reasons for the failure of Canadian Commercial and Northland banks was ________. A) moral hazard B) adverse selection C) the lack of deposit insurance D) rising oil prices
Answer: A
" "2) The Japanese equivalent of the CDIC played a ________ role in that country's banking crisis. A) tiny B) huge C) important D) dominant
Answer: A
" "2) The primary rationale for deposit insurance is ________. A) protecting depositors from bank insolvency B) increasing creditworthiness of subprime mortgages C) increasing barriers to entry in the banking industry to promote financial stability D) altering risk profiles of both banks and depositors
Answer: A
" "20) Regulations designed to provide information to the marketplace so that investors can make informed decisions are called ________. A) disclosure requirements B) efficient market requirements C) asset restrictions D) capital requirements
Answer: A
" "21) With ________, firms value assets on their balance sheet at what they would sell for in the market. A) mark-to-market accounting B) book-value accounting C) historical-cost accounting D) off-balance sheet accounting
Answer: A
" "22) Acquiring information on a bank's activities in order to determine a bank's risk is difficult for depositors and is another argument for government ________. A) regulation B) ownership C) recall D) forbearance
Answer: A
" "22) During times of financial crisis, mark-to-market accounting ________. A) requires that a financial firms' assets be marked down in value which can worsen the lending crisis B) leads to an increase in the financial firms' balance sheets since they can now get assets at bargain prices C) leads to an increase in financial firms' lending D) results in financial firms' assets increasing in value
Answer: A
" "24) A problem with the too-big-to-fail policy is that it ________ the incentives for ________ by big banks. A) increases; moral hazard B) decreases; moral hazard C) decreases; adverse selection D) increases; adverse selection
Answer: A
" "8) Deposit insurance is a guarantee by the CDIC to pay deposits off in full on the first ________ they have deposited in the bank. A) $60000 B) $200,000 C) $100,000 D) $150,000
Answer: C
" "25) An important factor in producing the subprime mortgage crisis was ________. A) lax consumer protection regulation B) onerous rules placed on mortgage originators C) weak incentives for mortgage brokers to use complicated mortgage products D) strong incentives for the mortgage brokers to verify income information
Answer: A
" "26) Regulators attempt to reduce the riskiness of banks' asset portfolios by ________. A) limiting the amount of loans in particular categories or to individual borrowers B) encouraging banks to hold risky assets such as common stocks C) establishing a minimum interest rate floor that banks can earn on certain assets D) requiring collateral for all loans
Answer: A
" "3) A common element in all of the banking crisis episodes in different countries is ________. A) the existence of a government safety net B) deposit insurance C) increased regulation D) lack of competition
Answer: A
" "3) The Bank of Credit and Commerce International (BCCI) operated in ________ countries prior to its collapse. A) 70 B) 5 C) 70 D) 50
Answer: A
" "3) The CDIC does not insure term deposits with an initial maturity date of more than ________. A) 5 years B) 2 years C) 1 year D) 90 days
Answer: A
" "4) In the 1998-1999 fiscal year, the flat rate insurance premium was ________. A) 1/6 of 1 percent B) 1/4 of 1 percent C) 1/3 of 1 percent D) 1/2 of 1 percent
Answer: A
" "4) The Basel Committee ruled that regulators in other countries could ________ of a foreign bank if they feel that it lacks effective oversight. A) restrict operations B) ban operations C) takeover D) merge operations
Answer: A
" "5) The Basel Accord, an international agreement, requires banks to hold capital based on ________. A) risk-weighted assets B) the total value of assets C) liabilities D) deposits
Answer: A
" "5) The Differential Premiums By-law came into effect for the premium year beginning ________. A) May 1, 1999 B) January 1, 1999 C) May 31, 1999 D) December 31, 1999
Answer: A
" "5) The Inspector General of Banks was the predecessor of the ________. A) Office of the Superintendent of Financial Institutions B) Office of Regulatory Forbearance C) Canadian Commercial Regulatory Committee D) Basel Committee
Answer: A
" "5) The cost of rescuing banks ranges from ________ to ________ percent of GDP. A) 1; 57 B) 1; 11 C) 1; 13 D) 4; 57
Answer: A
" "7) Bank failures in Canada arose due to historical accident, including ________ and ________. A) sharp increase in interest rates; severe recession B) sharp increase in interest rates; a housing boom C) sharp decrease in interest rates; severe recession D) sharp decrease in interest rates; a housing bubble
Answer: A
" "7) One of the problems experienced by the savings and loan industry during the 1980s was ________. A) managers lack of expertise to manage risk in new lines of business B) heavy regulations in the new areas open to S&Ls C) slow growth in lending D) close monitoring by the FSLIC
Answer: A
" "7) The Differential Premiums By-law classifies CDIC institutions according to their risk profile. ________ dominate the criteria. A) Capital adequacy measures B) Quantitative aspects C) Qualitative aspects D) CAMELS rating
Answer: A
" "7) To prevent bank runs and the consequent bank failures, the Canada established the ________ to provide deposit insurance. A) CDIC B) OSC C) Bank of Canada D) ATM
Answer: A
" "8) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk category 1 was ________. A) 1/36 of 1 percent B) 1/18 of 1 percent C) 1/9 of 1 percent D) 2/9 of 1 percent
Answer: A
" "8) The S&L Crisis can be analyzed as a principal-agent problem. The agents in this case, the ________, did not have the same incentive to minimize cost to the economy as the principals, the ________. A) politicians/regulators; taxpayers B) taxpayers; politician/regulators C) taxpayers; bank managers D) bank managers; politicians/regulators
Answer: A
" "9) Agreements such as the ________ are attempts to standardize international banking regulations. A) Basel Accord B) UN Bank Accord C) GATT Accord D) WTO Accord
Answer: A
"1) In the mid-1980s, how many chartered banks failed in Canada? A) Two B) Three C) Five D) Ten
Answer: A
"1) When depositors lack of information about the quality of bank assets it can lead to ________. A) bank panics B) bank booms C) sequencing D) asset transformation
Answer: A
" 16) What are the provisions under the October 15, 1999 Opting-Out By-law?
Answer: According to the By-law, Schedule III banks that accept primarily wholesale deposits (defined as $150,000 or more) could opt out of CDIC membership and therefore to operate without deposit insurance. The new legislation however includes provisions to protect depositors who hold deposits eligible for CDIC protection. These include the requirement for an opted out bank to inform all depositors by posting notices in its branches that their deposits will not be protected by the CDIC and not to charge any early withdrawal penalties for depositors who choose to withdraw.
" "13) The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem. A) adverse selection; adverse selection B) adverse selection; moral hazard C) moral hazard; adverse selection D) moral hazard; moral hazard
Answer: B
" "13) When bad drivers line up to purchase collision insurance, automobile insurers are subject to the ________. A) moral hazard problem B) adverse selection problem C) assigned risk problem D) ill queue problem
Answer: B
" "15) Banks will be examined at least once a year and given a CAMELS rating by examiners. The L stands for ________. A) liabilities B) liquidity C) loans D) leverage
Answer: B
" "8) The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same capital requirement is known as ________. A) competition in laxity B) depositor supervision C) regulatory arbitrage D) a dual banking system
Answer: C
" "18) Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry. A) moral hazard B) adverse selection C) ex post shirking D) post-contractual opportunism
Answer: B
" "2) Deposit insurance covers deposits up to $100,000, but as part of a doctrine called ""too-big-to-fail"" the CDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the CDIC does this, it uses the ________. A) ""payoff"" method B) ""purchase and assumption"" method C) ""inequity"" method D) ""Basel"" method
Answer: B
" "27) The ________ allowed chartered banks to own investment banking subsidiaries. A) Bank of Canada Act B) Financial Institutions and Deposit Insurance System Amendment Act C) Bank Holding Company Act D) Monetary Control Act
Answer: B
" "4) Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a ________. A) last-in, first-out constraint B) sequential service constraint C) double-coincidence of wants constraint D) everyone-shares-equally constraint
Answer: B
" "6) The Basel Accord requires banks to hold as capital an amount that is at least ________ of their risk-weighted assets. A) 10 percent B) 8 percent C) 5 percent D) 3 percent
Answer: B
" "9) In the early stages of the 1980s banking crisis, financial institutions were especially harmed by ________. A) declining interest rates from late 1979 until 1981 B) the severe recession in 1981-82 C) the disinflation from mid 1980 to early 1983 D) the increase in energy prices in the early '80s
Answer: B
" "9) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk category 2 was ________. A) 1/36 of 1 percent B) 1/18 of 1 percent C) 1/9 of 1 percent D) 2/9 of 1 percent
Answer: B
" "9) The primary difference between the ""payoff"" and the ""purchase and assumption"" methods of handling failed banks is ________. A) that the CDIC guarantees all deposits when it uses the ""payoff"" method B) that the CDIC guarantees all deposits when it uses the ""purchase and assumption"" method C) that the CDIC is more likely to use the ""payoff"" method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures D) that the CDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions
Answer: B
" "10) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk category 3 was ________. A) 1/36 of 1 percent B) 1/18 of 1 percent C) 1/9 of 1 percent D) 2/9 of 1 percent
Answer: C
" "14) An analysis of the political economy of the savings and loan crisis helps one to understand ________. A) why politicians aided the efforts of thrift regulators, raising regulatory appropriations and encouraging closing of insolvent thrifts B) why thrift regulators were so quick to inform Congress of the problems that existed in the thrift industry C) why thrift regulators willingly acceded to pressures placed upon them by members of Congress D) why politicians listened so closely to the taxpayers they represented
Answer: C
" "19) The current supervisory practice toward risk management ________. A) focuses on the quality of a bank's balance sheet B) determines whether capital requirements have been met C) evaluates the soundness of a bank's risk-management process D) focuses on eliminating all risk
Answer: C
" "2) The leverage ratio is the ratio of a bank's ________. A) assets divided by its liabilities B) income divided by its assets C) capital divided by its total assets D) capital divided by its total liabilities
Answer: C
" "20) When the CDIC takes control of the bank, rather than liquidate it, it believes that the takeover ________. A) was a good investment opportunity for the government B) could be part of a new governmentally owned banking system C) was too big to fail D) would become the center of the new central bank system
Answer: C
" "24) Competition between banks ________. A) encourages conservative bank management B) increases bank profitability C) encourages greater risk taking D) eliminates the need for government regulation
Answer: C
" "25) The too-big-to-fail policy ________. A) reduces moral hazard problems B) puts large banks at a competitive disadvantage in attracting large deposits C) treats large depositors of small banks inequitably when compared to depositors of large banks D) allows small banks to take on more risk than large banks
Answer: C
" "3) The fact that banks operate on a ""sequential service constraint"" means that ________. A) all depositors share equally in the bank's funds during a crisis B) depositors arriving last are just as likely to receive their funds as those arriving first C) depositors arriving first have the best chance of withdrawing their funds D) banks randomly select the depositors who will receive all of their funds
Answer: C
" "3) To be considered well capitalized, a bank's leverage ratio must exceed ________. A) 10 percent B) 8 percent C) 5 percent D) 3 percent
Answer: C
" "4) In terms of international banking crises, deposit insurance ________. A) was always a key factor B) couldn't be implicated as it only exists in Canada C) played a role in a few countries but wasn't consistently complicit D) is considered to be the best response to financial instability
Answer: C
" "4) Off-balance-sheet activities ________. A) generate fee income with no increase in risk B) increase bank risk but do not increase income C) generate fee income but increase a bank's risk D) generate fee income and reduce risk
Answer: C
" "6) CDIC premium revenue is ________. A) the same for all deposit taking institutions B) vary from 15 cents to 20 cents per dollar C) based on the risk profile of the member institution D) capped at 15 cents for ""worst"" institutions
Answer: C
" "6) Sometimes regulators refrain from putting insolvent banks out of business. This is also known as ________. A) a decrease in deposit insurance B) a decrease in interest rates to fight the inflation problem C) regulatory forbearance D) increased regulation that prohibited banks from making risky loans
Answer: C
17) Describe how the CDIC premiums have evolved over the past years.
Answer: CDIC premiums were fixed and unrelated to the risk profiles of the various member institutions. In 1999, the Differential Premiums By-Laws differentiated the premiums of member institutions according to a variety of both qualitative and quantitative aspects, dominated by capital adequacy measures.
" "11) Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in ________. A) reduced risk taking by banks B) reduced supervision of banks by regulators C) increased fraudulent behavior by banks D) increased risk taking by banks
Answer: D
" "12) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk category 4 was ________. A) 1/36 of 1 percent B) 1/18 of 1 percent C) 1/9 of 1 percent D) 2/9 of 1 percent
Answer: D
" "18) Since depositors, like any lender, only receive fixed payments while the bank keeps any surplus profits, they face the ________ problem that banks may take on too ________ risk. A) adverse selection; little B) adverse selection; much C) moral hazard; little D) moral hazard; much
Answer: D
" "18) The evidence from banking crises in other countries indicates that ________. A) deposit insurance is to blame in each country B) a government safety net for depositors need not increase moral hazard C) regulatory forbearance never leads to problems D) deregulation combined with poor regulatory supervision raises moral hazard incentives
Answer: D
" "21) If the CDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses. A) payoff; large B) payoff; no C) purchase and assumption; large D) purchase and assumption; no
Answer: D
" "23) Consumer protection legislation includes legislation to ________. A) require banks to make loans to everyone who applies B) reduce the amount of interest that bank's can charge on loans C) require banks to make periodic reports to the Better Business Bureau D) reduce discrimination in credit markets
Answer: D
" "23) The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely. A) small; fewer B) small; greater C) big; fewer D) big; greater
Answer: D
" "26) Which of the following is not a reason financial regulation and supervision is difficult in real life? A) Financial institutions have strong incentives to avoid existing regulations B) Unintended consequences may happen if details in the regulations are not precise C) Regulated firms lobby politicians to lean on regulators to ease the rules D) Financial institutions are not required to follow the rules
Answer: D
" "5) Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the ________. A) too-big-to-fail effect B) moral hazard problem C) adverse selection problem D) contagion effect
Answer: D
" "6) The Depository Institutions Deregulation and Monetary Control Act of 1980 ________. A) separated investment banks and commercial banks B) restricted the use of ATS accounts C) imposed restrictive usury ceilings on large agricultural loans D) increased deposit insurance from $40000 to $100,000
Answer: D
" "6) The contagion effect refers to the fact that ________. A) deposit insurance has eliminated the problem of bank failures B) bank runs involve only sound banks C) bank runs involve only insolvent banks D) the failure of one bank can hasten the failure of other banks
Answer: D
" "7) Under the Basel Accord, assets and off-balance sheet activities were sorted according to ________ categories with each category assigned a different weight to reflect the amount of ________. A) 2; adverse selection B) 2; credit risk C) 4; adverse selection D) 4; credit risk
Answer: D
"1) A bank failure is less likely to occur when ________. A) a bank holds less government securities B) a bank suffers large deposit outflows C) a bank holds fewer excess reserves D) a bank has more bank capital
Answer: D
"1) The CDIC does not insure ________. A) savings and chequing accounts B) term deposits with a maturity of less than 5 years C) money orders and drafts D) mutual funds
Answer: D
"1) The evidence from banking crises in other countries indicates that ________. A) deposit insurance is to blame in each country B) a government safety net for depositors need not increase moral hazard C) regulatory forbearance never leads to problems D) deregulation combined with poor regulatory supervision raises moral hazard incentives
Answer: D
30) What are the three pillars that Basel 2 is based on?
Answer: Pillar 1 links capital requirements for large, internationally active banks to three types of actual risk: market risk, credit risk, and operational risk. Pillar 2 focuses on strengthening the supervisory process. Pillar 3 focuses on improving market discipline through increased disclosure.
29) What is the "too-big-to-fail" policy of the CDIC? how is it associated with asymmetric information problems?
Answer: Students must explain that because the failure of a very large bank makes it more likely that a major financial disruption may occur, bank regulators are usually reluctant to allow a big bank to fail and cause losses to its depositors. Thus, the too-big-to-fail policy increases the moral hazard incentives of big banks as they know that they can take more risk as the CDIC will try and save them in case they encounter difficulties, instead of using the alternative payoff method according to which depositors are paid only up to $100,000 for their deposits in the event that the bank fails.
" 28) Banking regulation suffers from the principal-agent problem. Describe how this problem relates to regulators and politicians.
Answer: Taxpayers are the principals, and regulators and politicians are the agents. Regulators want to escape blame for poor performance, so they have incentives to loosen capital requirements and practice forbearance, the opposite of what they should do. Regulators must also please politicians, who in turn receive contributions from the banks being regulated. Thus, politicians may pressure regulators to practice forbearance, and fail to address problems if resolving problems conflicts with their personal interests.
" 27) The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.
Answer: The adverse selection problem occurs because risk-loving individuals might view the banking system as a wonderful opportunity to use other peoples' funds knowing that those funds are protected. The moral hazard problem comes about because depositors will not impose discipline on the banks since their funds are protected and the banks knowing this will be tempted to take on more risk than they would otherwise.
" 8) How did the increase in the interest rates in the early 1980s contribute to the insolvency of Canadian Commercial and Northland?
Answer: The banks suffered from an interest-rate risk problem. They had many fixed-rate mortgages with low interest rates. As interest rates in the economy began to climb, banks began to lose profitability. In addition, the 1981-1982 recession and a collapse in the prices of energy and farm products hit the economy of Alberta very hard. Losses mounted and the banks had negative net worths and were insolvent by 1985.