lecture 2 Flashcards
what is the invitability of instability?
the financial system is very fragile system where many things can go wrong . the system is risky and there is now way to change this
problems with indirect financing
liquidity risk : when deposits are much higher than loans
credit risk: risk of banks not being able to collect money they lend
interest rate risk: when interest rates go up a bank might have to pay a lot more on its deposits while interest rates on loans is fixed
why regolations?
_avoid monopolies
_protect consumers and investors
_internalize externalities
does concentrated banking sector cause instability?
not true because in canada and australia it didnt have an impact.
while in Belgium it had an impact
implications of financial crisis
drop prices of real estates drop price of stocks increase in unemployment drop in production increase in gevernment debt
problems with regulations
_facts precede rules: already too late ( after crisi)
_financial innovafion : design of new products to avoid regulation
_regulation is costly : to bank and society
_strict rules
what happen when a bank doesnt comply to the rules?
there has to be a punishment
but punishement may decrease trust in bank which would cause more instability
financial safety net?
causes of crisis are diverse while consequences are similar.
so we need rules that minimize the consequences
so we need a financial safety net: it has 4 components:
1. rules about founding and dissolving banks ( not everybody can just start a bank)
2. central bank as a lender of last resort
3.deposit insurance ( before 2009=20000/after 2009= 100000)
4.financial oversight ( micro and macro prudential)
how to improve capital requirement?
offer new share
avoid capital leaving the bank
convert debit into equity
decrease risk weighted assets
three pillars of basel capital requirements
- minimum capital requirements
- supervisory review
- marker discipline
misconception : capital vs liquidity
capital is on the right hand side of balance sheet ( liabilities) and cash is on the left ( asset)
capital requirements deal with how the firm finance itseld
liquidity requirements deal with the type of assets a firm has
missconception : return on equity
decrease in ROE is not necessarily a bad thing
ROE is a measure that does not take risk into account
higher capital requirements will lead to lower ROE
using ROE as a measure of profitability is wrong
banks invest mainly in ?
long term assets
banks liability are mainly?
short term liabilities
rules and regulations that deal with banks capital are commonly reffered to ?
basel regulations
interbank loans can be found on banks balancesheet under ?
both assets and liabilities
advantage of price stability ?
reduced inflation risk premium
prevent arbitrary wealth redistribution
improve consumption, savings and investment decisions
depository financial institutions include ?
saving banks
credit unions
commercial banks
when a house buyer borrows money from bank , what happen to his assets and liabilities?
both assets and liabilities increase
when does the money supply in economy increase?
when commercial bank buys government bond
QE by buying government bonds from pension funds .. what does increase ?
the total amount of ECB reserves and bank deposits
how QE stimulate the economy ?
decreasing interest rates
how can we reduce the risk of bank runs?
by enfourcing high reserve ratios
what happend because of the border problems?
money flowed to non regulated sectors during economic booms
what are components of financial safety net?
central bank
deposit insurance
financial oversight
capital requirements cannot be improved by
increasing RISK WEIGHTED ASSETS RWA
how expected losses are covered by ?
provisions
how are unexpected losses covered by?
equity
what does the formula for credit risk RWA under basel 1 and 2 assume ?
assume a portfolio in which no borrower is significant
what does a high RAROC means
the risk adjusted amount of capital is relatively low
where do most commercial bank profit comes from ?
net interest income
