Chapter 20

Question 1

What is deposit insurance

Answer 1

Insurance on deposits so CIDC, that guarantees if the bank can’t pay back their deposits for any reason, the CDIC will guarantee $250K of the amount deposited into the account

Question 2

What are the 3 causes of bank insolvency (bankruptcy)?

Answer 2

1) Significant rise in interest rates
2) Collapse in oil, real estate and commodity prices
3) Increased competition

Question 3

Explain moral hazard regarding FI

Answer 3

Deposits are insured for the bank which makes them take increased risk knowing they are covered, which puts more stress on CDIC and FDIC

Question 4

What is an argument against having deposit insurance

Answer 4

Moral hazard because banks mat take on more risks knowing their depositors will be bailed out by CDIC and FDIC

Question 5

What are the 5 things that determines the premium amount that is paid to CDIC or FDIC

Answer 5

1) the banks riskiness
2) their assets
3) what types of loans they offer and their concentration
4) their liabilities (insured or not)
5) history of losses and defaults

Question 6

What are risk adjusted premiums?

Answer 6

It is a premium that the FDIC collects based on the risk of the FI

Question 7

Which bank will pay more in premiums
Bank A: $100 in real estate loans
Bank B: $100 in T-bills

Answer 7

Bank A because their assets are much less liquid and therefore more risky

Question 8

What does it mean to be “too big to fail”

Answer 8

Means that if default was to happen it would impact the whole market , therefore the government won’t let them fail

Question 9

Who is the lender of last resort?

Answer 9

The central bank