class 7

Question 1

what is a government safety net?

Answer 1

a collection of programs that help banks if they are in trouble

Question 2

are banks firms that need funding?

Answer 2

yes

Question 3

what are the 3 problems between banks and depositors?

Answer 3

asymmetric information problems
potential adverse selection among banks
potential moral hazard by banks

Question 4

should depositors need to screen and monitor banks?

Answer 4

yes

Question 5

why should depositors need to screen and monitor banks?

Answer 5

to make sure they do not make poor decisions

Question 6

how do banks deal with people withdrawing?

Answer 6

they have a first-come-first-serve feature to withdraw deposits

Question 7

what does the first-come-first-serve feature cause?

Answer 7

it causes a strong incentive to withdraw deposits in case of doubt

Question 8

what are the 3 potential consequences that the first come first serve withdrawal feature causes?

Answer 8

bank run
bank failure
bank panic

Question 9

what is a bank run?

Answer 9

massive withdrawals of deposits from a bank that can cause a bank failure

Question 10

what is a bank failure?

Answer 10

when a bank is unable to meet its obligations so they must go out of business, this can cause a bank panic

Question 11

what is a bank panic?

Answer 11

massive withdrawals from multiple banks, even good banks can fail in a liquidity crisis, so expectations of bank failures can be self fulfilling prophecies

Question 12

what are the 2 companies that provide deposit insurance?

Answer 12

federal deposit insurance commission (FDIC) US
canada deposit insurance corporation (CDIC) canada

Question 13

what are the 3 other forms of government safety net?

Answer 13

lender of last resort (by central banks)
crisis support of financial institution:
capital injections
nationalize troubles institutions

Question 14

what was diamond-bybuig?

Answer 14

in 1983 they wrote a paper that gave solid evidence that needed we needed deposit insurance

Question 15

what is lender of last resort?

Answer 15

when the bank of canada lends emergency funds to avoid banks runs and financal instability

Question 16

what are capital injections?

Answer 16

when a bank is in trouble, the government gives bank additional cash in exchange for ownership in the bank

Question 17

what is nationalize troubled institutions?

Answer 17

the government covers all liabilities of a bank that cannot but takes full ownership in a bank that can’t meet its liabilities

Question 18

will the central bank help insolvent banks?

Answer 18

no

Question 19

what is an insolvent bank?

Answer 19

when a bank has more liabilities than assets

Question 20

is the government safety net a mixed blessing?

Answer 20

yes

Question 21

what are the 3 drawbacks to the government safety net?

Answer 21

insured depositors have less incentive to screen the banks

moral hazard

some banks are to-big to fail

Question 22

why is it a drawback that the government safety net makes insured depositors to screen the bank?

Answer 22

insurers have less incentive to screen the banks but the government doesn’t impose market discipline to make them act any different

Question 23

why Is moral hazard a draw back of banks having a government safety net?

Answer 23

the banks will have a greater incentive to take on greater risk due to them knowing that they have insurance and that they are unmonitored by insured depositors

Question 24

why is some banks being to-big-to-fail a drawback of banks having a government safety net?

Answer 24

since some banks are so big regulators are reluctant to close down large financial institutions and impose loses to their creditors because doing so might trigger a financial crisis

Question 25

what explains the reason for the need for financial regulation?

Answer 25

the drawbacks of government safety net explain the need for financial regulation

Question 26

what are the 8 types financial regulations?

Answer 26

restrictions on asset holding
capital requirements
prompt corrective action
financial supervision
assessment of risk management (new focus)
disclosure requirements
consumer protection
restrictions on competition

Question 27

what are 2 examples of restrictions on asset holding?

Answer 27

when banks cannot hold ownership in a company that they lend to

a banks overall lending cannot exceed more than 50% mortgages

Question 28

what are capital requirements?

Answer 28

when there are regulations that state how much capital a bank has to hold

Question 29

why is it important for capital requirements?

Answer 29

capital functions as a cushion when bad shocks occur, the capital adds to the safety and soundness of financial institutions

Question 30

what is the leverage ratio?

Answer 30

capital divided by total assets

Question 31

what are the 2 kinds of capital requirements?

Answer 31

leverage ratio
risk-based capital requirement

Question 32

what is the risk-based capital requirement?

Answer 32

the Basel accord requires banks to hold capital at lest 8% of their total risk-weighted assets

Question 33

what is the Basel accord?

Answer 33

requires banks to hold capital at least 8% of their total risk weighted assets

Question 34

what are the 4 different categories assets are allocated in to?

Answer 34

zero weight
20% weight
50% weight
100% weight

Question 35

what do the 4 different categories of assets reflect?

Answer 35

each weight reflects the degree of credit risk of each asset

Question 36

what assets are in the zero weight category?

Answer 36

reserve and government securities

Question 37

what assets are in the 20% weight category?

Answer 37

claims on banks (holdings of bonds issued by other banks)

Question 38

what assets are in the 50% weight category?

Answer 38

municipal bonds and residential mortgages

Question 39

what assets are in the 100% weight category?

Answer 39

loans to consumers and companies

Question 40

what is Basel II?

Answer 40

it was supposed to be implemented in 2007 but it was not after the financial crisis

Question 41

what is Basel III?

Answer 41

fully implemented in cananda in 2023, this made capital counter secular, making banks have higher capital ratios and lend less in good economies and have lower capital ratios and lend more in poor economies

it also made big banks have a higher capital, 10%-11% instead of 8%

Question 42

how do you get risk-weighted capital ratio?

Answer 42

capital/ the sum of all assets times their risk category

(check note 7 slide 10)

Question 43

what is prompt corrective action?

Answer 43

when there is large capital loss, the CDIC will intervene to stop further capital loss

Question 44

what are the 2 kinds of financial supervision?

Answer 44

regulatory filing
on-site examinations

Question 45

what are regulatory filing?

Answer 45

evert month, every bank needs to submit what loans they made to OSFI to pass on to the BOC

Question 46

what are on-site examinations?

Answer 46

OSFI regularly visits large banks to check on them

Question 47

when did assessment of risk management become the new focus?

Answer 47

after the 2007 financial crisis

Question 48

what are the 2 kinds of assessment of risk management?

Answer 48

internal risk control process
stress tests

Question 49

what are internal risk control process?

Answer 49

they control what risk is being taken

Question 50

what are stress tests?

Answer 50

when the regulators create bad scenarios and see if the bank can still survive

Question 51

what is an example of a stress test?

Answer 51

when the regulators see if a bank can survive the housing market dropping by 30%

Question 52

what are disclosure requirements?

Answer 52

when banks need to report securitization

Question 53

what is consumer protection?

Answer 53

when regulators protect the interest of consumers and make sure consumers are not mislead

Question 54

what is an example of consumer protection?

Answer 54

when Wells Fargo created accounts under peoples names to benefit the tellers, the regulators would intervene here

Question 55

what are restrictions on competitions?

Answer 55

when regulators do not want to many banks in a country and need banks to receive a charter to open

Question 56

why night more and intense competition in financial markets be a bad idea?

Answer 56

because the banks would lower interest they charge on loans to attract customers and would have to take higher risks to make up for the loss of profit from their lower interest