Bank risk Flashcards
How does a risk averse agent act in relation of Risk premium?
The expected return of holding an uncertain asset must being higher than the certain return of capital. They must be compensated for holding risk in the form of a risk premium.
Why won’t credit work in the 3 period OLG?
Although theoretically middle aged could borrow from young and then repay when capital income comes in. Cannot happen:
-Impossible to observe capital that belongs to others
- Anyone can hide from their renters
-> money is needed.
What does aggregate certainty mean in relation to the 3 period OLG
Everyone knows that exactly half are early type, half are late, but they cannot identify who is who.
Why is demand deposit banking needed in 3 period OLG?
Due to idiosyncratic uncertainty, nobody can be sure they are getting the best rate of return possible:
-If they incorrectly think they are late but are early will have to sell capital at reduced rate.
What bank activity creates the conditions for a bank run
- Mismatch of maturity of bank assets and labilities
- Defining characteristic of banks is that they have liabilities possible on demand (demand deposit banking)
What is a modern bank run?
Unable to roll over short term debt, unable to borrow funds from other financial institutions.
What happened in the Argentina bank run?
- Financial and fiscal crisis
-Full-fledged bank run Nov 2001 - People wanting to withdraw pesos and convert to USD and send overseas.
What is Grexit?
- Fears over Greece leaving Euro-zone -> massive withdrawals
- In 3 days 3 billion Euros withdrawn from Greek banks
What are the 4 ways of preventing bank panic?
- Interbank lending
-> may not have to sell capital for loss - Suspension of withdrawals
-> shut doors once reserves of storage used up
->Then late type know investment is safe -> no panic
-> e.g. Greece limit of 60 Euros a day - Identification of people
-> Then banks can refuse certain people (late)
->key is to make people worse off who rush
Government deposit insurance
-> UK PRA 85,000
