Lecture 5 - Banking Crises Flashcards
Other than losing money through bad
loans i.e., customer failing to pay back a loan, how can a bank lost money?
Banks can also sometimes make bad investments in other assets such as stocks or bonds.
Why is an Asset fire sale (bank selling off non-liquid assets quickly) bad for a bank?
this often requires a bank to sell assets for less than if they had been sold in amore orderly manner
Are bank runs contagious?
Yes. Northern Rock’s problems were triggered by US banks with similar-looking business models getting into trouble rather than clear problems with the value of its assets
Loans =
Deposits + Other Borrowings and bank cash and securities holdings, all of which lead to a lower quantity of loans
What is a Credit Crunch
when banks are no longer in a position to lend to borrowers and financial intermediation breaks down - both banks and customers contribute to a credit crunch
Additional Complications in Modern Banking Crises:
- Non-deposit funding: many modern banks obtain substantial non-deposit funding via bond markets or inter-bank money markets. These provider are more prone to “run” than depositors, who are often viewed as a “sticky” source of funding
- Interbank Linkages: Funding links between banks can mean that the failure of one bank can directly threaten the failure of other banks.
- Financial Assets and Negative Feedbacks: Many banks now have very large holdings of financial assets, whose valuation (unlike loans) are set in the market every day. During crises, we can se negative feedback loops involving banks selling assets, which then decline in value, thus making bank solvency problems even worse.
Why more non-deposit funding?
- Deepening of Financial Markets: Modern financial systems contain more options than in the past for people to channel their savings towards. Two that are relevant for banks are pension funds, which commonly buy bonds issued by banks and money market mutual funds, which commonly make shorter-term loans to banks
- Financial Globalisation: In closed economies, savings must equal investment. Banks that are provided with savings from depositors must make loans within their own country. In an open economy, savings do not need to equal investment. In a country that has high savings but low investment, banks will often lend funds to banks in other countries.
- Deregulation: Regulations about where banks get funds from, and who they can loan these funds to, have generally been loosened over time.
Who do modern bank runs come from?
mainly from those who lend money t banks through interbank markets and bond markets deciding not to continue to supply a ban with funds
Why do interbank market make easier?
Interbank markets make it easier for banks to cope with reserve requirements (by lending and borrowing short-term funds) and allowing banks with lots of deposits but without good loan opportunities to lend to bank with good loan opportunities but limited deposits. - they also contribute to making the banking system unstable
Systemic Risk
Due to banks borrowing from other banks if one bank goes insolvent this can have a knock-on effect for other banks
Why have modern banking regulations required banks to “mark their tradable assets to market” as much as possible?
So if the failure of one bank leads to the prices for some financial markets falling, then other banks have to mark down the value of their assets also
The Bank-Sovereign “Doom Loop”
The euro crisis of 2011/12 illustrated a new form of systemic risk. The interaction between banks and governments
Sub-prime mortgage lending
borrowing by people with poor credit records
securitisation
when banks would bundle together a set of mortgages and use their repayments to provide the income flows for securities that would be purchased by investors. These Mortgage-backed securities (MBS) were risky
Why were mortgage-backed securities risky?
If people defaulted on the mortgages, then the investors who bought these securities would lose money
