Chapter 8 - Banking and the Management of Financial Institutions

Question 1

Much of the last financial crisis can be attributed to what sort of activities?

Answer 1

off-balance-sheet activities (service charges, etc)

Question 2

How is a bank defined in federal law?

Answer 2

accepts deposits from savers AND makes loans to borrowers

Question 3

What do banks do?

Answer 3

efficient at matching savers and borrowers, pooling funds, gathering information about borowers

Question 4

General accounting equation?

Assets =

Answer 4

Liabilities + Capital
or
Debt + Equity

Question 5

Bank Liabilities (Sources of Funds)

Answer 5

• Transaction Deposits
• Non-transactions Deposits
• Bank (equity) Capital
• Borrowing

Question 6

Bank Assets (Uses of Funds)

Answer 6

-Loans
-Securities (US Gov’t, Agency Securities and Munis)
-Reserves & Cash Items
Other Assets (buildings and infrastructure, etc)

Question 7

If a bank can’t meet reserve requirements, what do they do?

Answer 7

Transform Assets or Borrow

Question 8

What is the best option for banks to meet the reserve requirement?

Answer 8

Borrow in the Fed Funds Market from other banks - lowest cost loans on the market (typically 3-4%)

Question 9

What is the cost to banks for selling US Gov’t securities to meet reserve requirements?

Answer 9

The loss of revenue generating assets - may also prevent the bank from meeting secondary reserve requirements

Question 10

What is the advantage to banks that lend through repurchase agreements to provide funds to banks to meet reserve requirements?

Answer 10

The bank makes interest for the duration of agreement on the securities and the loan is fully collateral (if a bank can’t repurchase at the end of the time frame, the lending bank now owns the securities)

Question 11

What are the explicit and implicit cost of using discount window borrowing?

Answer 11

Explicit: the discount rate levied to borrow funds
Implicit: makes an indication to the Federal Reserve that you are unable to borrow from other banks in the private sector and may send in bank regulators to do a bank audit

Question 12

What does it mean when a bank calls in loans?

Answer 12

The bank stops allowing high quality customers from using lines of revolving credit (pre-approved, on demand loans)

Question 13

What is the cost to banks when they sell loans to meet the reserve requirement?

Answer 13

Loans must be sold at less than face value (due to default risk) which must be made-up in loss of bank equity capital