6 Flashcards
- Bank Run, history: 1620s
During the Thirty Years war, German city-states minted imitations of rival cities coins using lesser metals
- Bank Run, history: 1772:
Financial Haggis (UK):
Scottish bank had lost customer money in risky speculation. Triggered chaos that took down almost all of the country’s private banks. Inspired the parliament to pass the Tea Act.
- Bank Run, history: 1873:
The Great Freakout of 1873 (Western Hemisphere):
Customers demanded gold for cash. Economic crisis. US sent army to war with Native Americans in area with gold
- Bank Run, history: 1914:
Schwenk Bank run (New York):
State banking regulators seized three banks owned by Schwenk, due to dodgy accounting.
- Bank Run, history: 1930s:
The Great Depression (U.S):
Over 9,000 banks failed.
- Bank Run, history: 1980s:
Savings-and-Loan Crisis (U.S.):
- Bank Run, history: 2001:
Great Depression of Argentina
Not enough dollar to cover all deposits. Had to put restrictions on withdrawal
- Bank Run, history: 2011-present:
EuroBlown (Greece):
High public spending, big debt
A quarter of all deposits have been pulled from Greek banks over two years
- Give examples of historical bank runs
1620s: Currency problems in Germany (Germany)
1772: Financial Haggis (UK)
1873: The Great Freakout of 1873 (Western Hemisphere)
1914: Schwenk Bank Run (New York)
1930s: The Great Depression (US)
1980s: Savings-and-Loan Crisis (US)
2001: Malos Aires (Argentina)
2011-present: EuroBlown (Greece)
- What happened after stock market crash of October 1929 in US:
- Wealthy people pulled out money from banks
- Less capital available = less capital for businesses and individuals
- Less capital for businesses and individuals = decline in production and employment
- Wave of Bank runs
- What will a bank have to do in the case of a bank run?
The bank needs to come up with the necessary cash:
a) Liquidate loans (sell the loans, securitize them, borrow from a central bank)
b) Sell assets (often at rock-bottom prices)
- When was the last wave of bank runs during the great depression?
Through the winter of 1932 and into 1933
- Who was the president during the Great depression, and what did he do to end it?
Franklin D. Roosevelt
a) National Bank Holiday (Temporarily closure to access their solvency)
b) New Banking Legislation: The Emergency Banking Act of 1933 (aimed to separate good and bad banks)
c) The New Deal. For employment
d) Spoke on Radio: Public confidence “fireside chats”
- What was the “fireside chats”?
Roosevelts speeches on radio to gain peoples confidence in banks
- How big was Lehman Brothers compared to others?
Fourth largest U.S. Investment Bank
- What was the reason for Lehman Brothers default?
Collapse of US housing market, due to its investment s in the subprime mortgage market
- How did the Lehman Brothers “buy the bubble”?
Acquired five mortgage lenders, including subprime lenders which specialized in Alt-A loans
- What is Alt-A loans?
Type of mortgage loan. Lower income and fewer documentation requirement. A loan that is more easy for borrowers to get.
- How did the Lehman Brothers do in the period 2004 – 2007, and why?
Recorded profits every year from 2005 - 2007
- Why did the Lehman Stock fall sharply in August 2007
Credit crisis with the failure of two Bear Stearns hedge funds.
- What was BNC
A Subprime mortage lender that was a subsidiary of Lehman. Known for its aggressive lending practices – offering many subprime mortgages – Which was pooled together and sold.
- What did Lehman do to try to prevent crisis in August 2007?
a) Shut down its BNC unit.
b) Closed offices of Alt-A lender Aurora in three states
c) Positive public messages from CFO
How much involved did Lehmann get in the mortgage market in 2007?
In 2007 they underwrote more mortgage-backed securities than any other firm
- Why was Lehman so vulnerable?
High degree of leverage - ratio of assets to shareholders equity was 31.
Investments was in the subprime mortgage market
- What were Lehman Brothers “last hope” – and how did it go?
Hopes that the state-owned bank of South Korea – Korea Development Bank – would take a stake in Lehman were dashed on September 9th.
- KDB did not take a stake. What happened to Lehman after this?
a) Big plunge in Stock
b) Big increase in credit-default swaps on the company’s debt
c) Hedge Fund clients started to withdraw their investments
d) Short-term creditors cut credit lines
Bankruptcy in September 2008
- Why is the case of Lehman Brothers similar to a traditional bank run?
The underlying reasons are similar. Institutional investors stopped funding the investment bank, and due to liquidity problem, they went bankrupt.
- What is the Diamond-Dybvig Model?
- Model of bank runs and related financial crises.
- It shows how a mix of illiquid assets (such as mortgage loans) and liquid liabilities (deposits which may be withdrawn at any time) may give rise to self-fulfilling oanics among depositors.
- How to stop a Bank Run or Panic?
a) Suspension of Convertibility
(Roosevelt, 1933: National Bank Holiday)
b) Coalition of Private Banks
(2008: Northern Rock – Barclays, Lloyd, Royal Bank of Scotland)
c) Government Deposit Insurance
(1934: Federal Deposit Insurance Corporation (FDIC))
d) Capital Requirement and Cash Requirement
(always)
e) Lender of Last Resort
(1914: Reichsbank, Schwenk. Also, many in 2008)
f) Government Bailouts
(2008: Several governments, U.S: TARP)
g) Equity Injections
(2011: Government and International institutions provided equity to Greece)
- Explain Suspension of Convertibility
Banks get closed to prevent people from pulling money out (like Roosevelt in 1933)
- Explain Coalition of Banks
Banks go together and borrows “clearinghouse loan certificates” from “clearinghouses”
- Explain Deposit Insurance
The government insure the people that they will give the people their money in case of bankruptcy
- Explain Capital Requirement or cash requirement
A bank has to hold an amount of reserves
- Explain Lender of Last Resort
Bank run will stop if people are not afraid that the bank will run out of money. Hence, central banks can back up private banks.
- Explain Government Bailouts
Central bank buys from private bank.
a) Liquidity injection
b) Equity injection
- Why is Suspension of Convertibility more difficult today compared to before?
Because of new technology and digital banking.
a) Would be to complex blocking or restricting access to digital accounts, freezing electronic transfers, and enforcing restrictions on digital transactions
b) Cryptocurrencies that operate beyond governemnts
- Why has Europe never had to use the Suspension of Convertibility?
Banks have not ran out of money because of Lender of Last Resort. Commercial banks have borrowed money from the European Central Bank.
- What is a clearinghouse?
A “middle-man” between buyer and seller.
- What is “clearinghouse loan certificates”?
Short term loans or promissory notes backed by the collective resources of the coalition banks
- Why did central banks emerge?
Evolved as a response to the inability of the commercial banks to cope with panics
- Where can you find Deposit Insurance today, and how does it work?
Most countries in Europe.
- In which cases will Deposit Insurances not be enough to prevent a run?
When the government itself run out of money
- What is one solution that has been proposed to the risk of Deposit Insurance?
Deposit insurance backed by the whole eurozone.
- Taxpayers of Germany would have to pay for financial stability in Greece.
- How will Capital Requirement usually be expressed?
As a ratio of equity that must be held as a percentage of risk-weighted assets.
- Why are Capital/Cash requirements put into place?
Often as a ratio of equity that must be held as a percentage of risk-weighted assets.
This is good because:
a) Bank cannot take too much leverage
b) Bank have liquid funds in times of distress
- What has been essential in preventing a full-scale bank run in Europe?
European Central Bank as Lender of Last Resort
- How has FED acted as a Lender of Last Resort?
Have given loan to private firms, hence put taxpayers money at risk
- How could the FED LLR avoid the problems it has created?
Don’t lend to private firms
Liquidity injection through ….?
Asset Purchase
Debt Guarantee
Direct Debt
- How does a Liquidity injection work?
Central banks purchase private assets and debt
- How does equity injection work?
Central banks purchase newly issued preferred stock in major banks
- How did the Government raise Credit Availability during the 2008 crisis?
a) Removing Poisonous Assets:
• Programs like TARP, where government bought troubled assets, like mortage-backed securities from financial institutions
b) Debt Guarantee:
• Government pays debt for another party. Makes it easier for banks to do liquidity things.
c) Relaxing the requirement of collateral
• Bank gets to access funding by using a broader range of assets as collateral (also those who might have lost value)
d) Increase Borrowers Net Worth:
• Individuals and Businesses. Financial Assistance
- Disadvantages of Suspension of Convertibility
Stops people who genuinely need money to withdraw.
- Disadvantages of Coalition of Banks
If all banks are suffering from common shock, it does not work
- Disadvantages of Deposit Insurance
a) Moral Hazard: Depositors feel that they don’t have to monitor the banks. So banks are not restricted from taking higher risks. Hence, the bank can take higher risk by lending out more money.
b) Too-Big-To-Fail: Banks covered by Deposit Insurance. Failure of a covered bank can trigger a chain reaction. Banks owe money to each other
- Disadvantages of Capital Requirement or cash requirement
Reduces the efficiency of a bank’s use of money and hence increases the costs of credit for the entire economy
- Disadvantages of Lender of Last Resort
Creates moral hazard on a massive scale, exposes the central bank to large financial risk, and blurs the boundary of fiscal policy.
- Disadvantages of Government Bailouts
Too-Big-To-Fail creates Moral Hazard. Signals to market that risky banks will be saved regardless of risky behaviour
- What is the main argument for Bank Regulation?
Too-Big-To-Fail
certain banks, due to their size, complexity, or interconnectedness with the financial system, pose a significant risk to the overall economy if they were to fail
- What are the general principles of Bank Regulation
a) Licensing and supervision
* Banks usually need banking license from national bank.
* The regulator supervises licensed banks
b) Minimum Requirements
* National bank imposes requirements for banks, often closely tied to the level of risk exposure.
* Most important: Maintaining minimum capital ratios
c) Market Discipline
* Banks must publicly disclose financial statements
- What is Licensing and Supervision?
Bank needs license and have to comply with requirements from government
- What is Minimum Requirements in Bank Regulations?
National bank imposes requirements on banks. Often, these will be closely linked to risk
- What is Market Discipline in Bank Regulations?
Regulator requires that banks publicly disclose financial and other information so that depositors and creditors can see this info.
- What are the instruments and Requirements of Bank Regulation?
a) Capital Requirement
- How banks must handle their capital in relation to their assets
b) Reserve Requirement
- Lost the role it had, as the emphasis has moved to capital adequacy
c) Corporate Governments (Encourage bank to be well managed)
- Legal entity, number of directors, organization structure
d) Financial reporting and disclosure requirements
- Requirement of disclosure of banks finances
e) Credit Rating Requirement
- May be required to obtain credit rating given by credit rating agency
f) Large exposures restrictions
- Prevent banks from having overly large financial exposures to specific individuals or groups of related individuals
g) Activity and Affiliation
- Limit activities banks can engage in and the relationship they can have with other financial institutions
- Explain Capital Requirement
A framework of how banks must handle their capital in relation to their assets
- Explain Reserve Requirement
The minimus reserves each bank must hold to demand deposits and banknotes
- Explain Corporate Governance
Intended to encourage the bank to be well managed, and is an indirect way of achieving other objectives.
- What might be some Corporate Governance Requirements?
a) To be a body corporate
b) Be incorporated locally rather in a foreign jurisdiction
c) Minimum number of directors
d) Have an organizational structure that includes various offices and officers.
- Explain financial reporting and disclosure requirements
Quarterly and Annual financial statements .
- Explain credit rating requirements
Banks may be required to obtain and maintain a current credit rating from an approved credit rating agency, and show it to the public
- Explain large exposures restrictions
Banks may be restricted from having imprudently large exposures to individual counterparties or groups of connected counterparties
- What did Roosevelt come with in 1933
The New Deal
