mid term 2 review Flashcards
1
Q
what are considered liabilities
A
checkable deposits, nontransaction deposits, borrowings, bank capital
2
Q
what are considered assets
A
reserves, cash items in process of collection, deposits at other banks, securities, loans
3
Q
assets are
A
uses of funds
4
Q
liabilities are
A
sources of funds
5
Q
what does the opening of a checking account lead to an increase in
A
opening of a checking account leads to an increase in the banks reserves equal to the increase in checkable deposits
6
Q
when a bank gains and loses deposits what are the effects
A
when a bank receives additional deposits it gains an equal amount of reserves when it loses deposits it loses an equal amount of reserves
7
Q
what is asset transformation
A
asset transformation is selling liabilities with one set of characteristics and using the proceeds to buy assets with a different set of characteristsics
8
Q
how to banks borrow and lend
A
banks borrow short and lend long
9
Q
what are the general principles of bank managament
A
liquidity management, asset management, liability management, capital adequacy management, credit risk, interest rate risk
10
Q
a bank has ample excess reserves
A
if a bank has ample excess reserves, a deposit outflow does not necessitate changes in other parts of its balance sheet
11
Q
excess reserves and insurance
A
excess reserves are insurance against the costs associated with deposit outflows
12
Q
cost of borrowing
A
the cost of borrowing is the interest rate paid on the borrowed funds
13
Q
what is the cost of selling securities
A
the cost of selling securities is the brokerage fee and other transaction costs
14
Q
discount rate
A
interest rate when borrowing funds from the fed
15
Q
what happens if a bank needs to reduce loans
A
reduction of loans is the most costly way of acquiring reserves, calling in loans antagonizes customers other banks may only agree to purchase loans at a substantial discount
16
Q
what are the three goals of asset managment
A
seek the highest possible returns on loans and securities, reduce risk, have adequate liquidity
17
Q
what are the 4 tools of asset managment
A
find borrowers who will pay high interest rates and have low possibility of defaulting on loans, purchase securities with high returns and low risk, lower risk by diversifying assets, balance need for liquidity against increased returns from less liquid assets
18
Q
what does having bank capital help prevent
A
bank capital helps prevent bank failure
19
Q
return on assets
A
net profit after taxes per dollar of assets
ROA=net profit after taxes/assets
20
Q
return on equity
A
net profit after taxes per dollar of equity capital
ROE= net profit after taxes/equity capital
21
Q
what is the relationship between ROA and ROE?
A
it is the equity multiplier which is the amount of assets per dollar equity capital
EM=Assets/Equity Capital
22
Q
equity multiplier
A
Net profit after taxes/equity capital= net profit after taxes/assets X assets/equity capital
23
Q
what is the trade off between safety and returns to equity holders
A
benefits the owners of a bank by making their investment safe, costly to owners of a bank bc higher the bank capital the lower return on equity, choice depends on the state of the economy and levels of confidence
24
Q
what happens if you have a short fall of bank capital
A
a shortfall of bank capital is likely to lead a bank to reduce its assets and tf is likely to cause a contraction in lending
short falls of bank capital led to slower credit growth
25
managing credit risk
screening, specialization in lending, monitoring and enforcement of restrictive covenants, long term customer relationships, loan commitments, collateral and compensating balances, credit rationing
26
FDIC
federal deposit insurance corporation: short circuits bank failures and contagion effect
27
Payoff method
a resolution method for a failed bank or thrift in which the FDIC directly pays the insured amount of each insured depositor
28
Purchase and assumption method
a transaction in which a healthy bank or thrift purchases assets and assumes liabilities including all insured deposits from an unhealthy bank typically more costly for the FDIC
29
form of government safety net
lending from the central bank to troubled institutions this is lender of last resort to get money from the central bank
30
Moral Hazard
depositors do not impose discipline of marketplace, financial institutions have an incentive to take on greater risk
31
Adverse selection
risk lovers find banking attractive, depositors have little reason to monitor financial institutions
32
idea of too big to fail
government provides guarantees of repayment to large uninsured creditors of the largest financial institutions even when they are not entitled to this guarantee, it uses the purchase and assumption method, increases moral hazard incentives for big banks
in simple terms: large financial institutions are so important to the overall economy that the government wont let them collapse even if they make bad choices
33
what ways are financial institutions restricted from too much risk taking
bank regulations: promote diversification, prohibit holdings of common stock
capital requirements: minimum leverage ration, basel accord which requires risk based capital requirements, regulatory arbuitrage
34
government imposed capital requirements
another way of minimizing moral hazard at financial institutions
35
what are the two government imposed capital requirements
1. based on the leverage ratio: the amount of capital divided by the banks total assets, it must exceed 5% a lower leverage ratio especially one below 3% triggers increased regulatory restrictions on the bank
2. risk based capital requirements
36
pillar 1 of basel accord
links capital requirements for large internationally active banks more closely to actual risk of three types: market risk, credit risk, operational risk
37
pillar 2 of basel accord
focuses on strengthening the supervisory process assessing the quality of risk management particularly in assessing the quality of risk management and evaluating whether these institutions have adequate procedures in place for determining how much capital they need
38
chartering
screening of proposals to open new financial institutions to prevent adverse selection
39
examinations
scheduled and unscheduled to monitor capital requirements and restrictions on assets holding to prevent moral hazard
40
what can increased competition do
it can increase moral hazard incentives to take on more risk, can lead to higher consumer charges and decreased efficiency
41
origins of the federal reserve system
resistance to establishment of a central bank, no lender of last resort, federal reserve act of 1913 which created elaborate system of checks and balances and decentralization
42
what entities are part of the federal reserve system
federal reserve banks, board of governors of the federal reserve system, federal open markets committee (FOMC) federal advisory council
43
who makes up the board of directors for federal reserve banks
3 are professional bankers, 3 are industry leaders, 3 are appointed by board of governers and are not allower to be officers, employees, or stock holders of banks
44
functions of the federal reserve banks
clear checks, issue new currency, withdraw damaged currency from circulation, administer and make discount loans to banks in their districts, evaluate proposed mergers and applications for banks to expand their activities
act as liaisons between the business community and federal reserve system, examine bank holding companies and state chartered member banks, collect data on local business conditions, use staffs of professional economists to research topics related to the conduct of monetary policy
45
special role of the federal reserve bank of NY
federal reserve bank of NY district contains many of the largest commercial banks in the united states, its also very active in bond and foreign exchange markets its the only federal reserve bank to be a member of the bank for international settlements, and lastly the president of the NY fed reserve bank is the only permanent voting member of the FOMC
46
who are three most important officials in the federal reserve system
president of the NY federal reserve bank, chair and vice chair of board of governors
47
who establishes discount rate
directors
48
what do federal reserve directors do
establish discount rate, decide which banks can obtain discount loans, select one commercial banker from each district to serve on the federal advisory council
49
federal advisory council
consults with the board of governors and provides information to help conduct monetary policy
50
who has vote on FOMC
5/12 bank presidents have vote in federal open market committee
51
members of federal reserve system
all national banks are required to be members, commerical banks chartered by states are not required but can choose to be members
52
board of governors of the federal reserve system
seven members headquartered in DC, appointed by president confirmed by senate, 14 year non renewable term, required to come from different districts, chairman is chosen from the governors and serves 4 year term
53
duties of the board of governors
votes on conduct of open market operations, sets reserve requirement, controls discount rate, sets margin requirements, sets salaries of president and officers of each federal reserve bank
approves bank mergers and applications for new activities, specifies the permissible activities of bank holding companies, supervises the activities of foreign banks operating in the united states
54
responsibilities of chairman of the board of governors
advises president on economic policy, testifies in congress, speaks for the federal reserve system to the media, may represent the united states in negotiations with the foreign governments on economic matters
55
how often does FOMC meet
8x per year
56
who makes up FOMC
consists of 7 members of board of governors, president of federal reserve bank of ny and the presidents of 4 other reserve banks
57
who is chairman of FOMC
board of governors
58
what does FOMC do
issues directives to the trading desk at the federal reserve bank of NY
59
what occurs at the FOMC meeting
repots of open market operations on foreign currency, domestic open market operations, outline different monetary policy actions,
60
how independent is the fed
instrument and goal independent, independent revenue, structure is written by congress and subject to change
61
what is the presidents influence on the fed
influence on congress, appoints members, appoints chairman although terms are not concurrent
62
case for independence of the fed
The strongest argument for an independent central
bank rests on the view that subjecting it to more
political pressures would impart an inflationary bias to
monetary policy
Political pressure would impart an inflationary bias to
monetary policy
* Political business cycle
* Could be used to facilitate Treasury financing of large
budget deficits: accommodation
* Too important to leave to politicians—the principal-agent
problem is worse for politicians
63
case against independence of the fed
Proponents of a Fed under the control of the president
or Congress argue that it is undemocratic to have
monetary policy (which affects almost everyone in the
economy) controlled by an elite group that is
responsible to no one.
Undemocratic
* Unaccountable
* Difficult to coordinate fiscal and monetary policy
* Has not used its independence successfully
64
theory of bureaucratic behavior
the objective of a bureaucracy is to maximize its own welfare that is related to power and prestige, fight to preserve autonomy, avoid conflict with more powerful groups
does not rule out altruism
65
structure of euro central bank
patterned after federal reserve, central banks from each country play similar role as fed banks, Executive Board:
– President, vice-president, and four other members
– Eight year, nonrenewable terms
* Governing Council
66
differences btw euro system central banks and fed reserve system
National Central Banks control their own budgets and the
budget of the ECB
* Monetary operations are not centralized
* Does not supervise and regulate financial institutions
67
euro governing council
Monthly meetings at ECB in Frankfurt, Germany
* Nineteen National Central Bank heads and six Executive
Board members
* Operates by consensus
* ECB announces the target rate and takes questions from
the media
* To stay at a manageable size as new countries join, the
Governing Council will be on a system of rotation.
68
how independent is ECB
Most independent in the world
* Members of the Executive Board have long terms
* Determines own budget
* Less goal independent
– Price stability
* Charter cannot by changed by legislation; only by
revision of the Maastricht Treaty
69
who are the three players in the money supply
the central bank, banks, depositors
70
who is the central bank
the federal reserve system
71
banks
depository institutions, financial intermediaries
72
depositors
individuals and institutions
73
liabilities for the fed
currency in circulation whats in the hands of the public, reserves bank deposits at the fed and vault cash
currency in circulation, reserves
74
feds assets
government securities holdings by the fed that affect the money supply and earn interest and discount loans
securities, loans to financial institutions
75
discount loans
provide reserves to banks and earn the discount interest rate
76
control of the monetary base
MB=C+R
C= currency in circulation
R= total reserves in the banking system
77
what happens when there is an open market purchase from a bank
net result is that reserves have increased by 100, there is no change in currency and the monetary base has risen by 100 bc increase in reserves
78
what happens when there is an open market purchase from the non public
person selling the bonds cashes the feds check, reserves are unchanged, currency in circulation increases by the amount of the open market purchase, monetary base increases by the amount of the open market purchase
79
what does the effect of an open market purchase depend on
the effect of an open market purchase on reserves depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits
80
in general what are the effects of the open market purchase
the effect of an open market purchase on the monetary base always increases the monetary base by the amount of the purchase
81
what are the effects of an open market sale
reduces the monetary base by the amount of the sale, reserves remain unchanged, the effect of open market operations on the MB is much more certain than effect on reserves
82
loans to financial institutions
if you have a new loan of 100 the monetary liabilities of the fed have increases by 100 and the monetary base also increases by 100
83
factors that affect MB
float, treasury deposits at the federal reserve, interventions in the foreign exchange market
84
who controls open market operations
the fed
85
what amount can the def not determine
the fed can not determine the amount of borrowing by banks from the fed
86
what are the two components of the monetary base
MBn=MB-BR
the money supply is positively related to both the non borrowed and borrowed monetary base MBn and to the level of the borrowed reserves BR from the fed
87
how do depositors decisions and banks decisions affect money supply
depositors decisions (how much currency someone decides to hold) and banks decisions (amount of excess reserves to hold) cause money supply to change
88
how do changes in required reserve ratio affect Money supply
money supply is negative related to required reserve ratio
89
how do changes in excess reserves affect money supply
money supply is negatively related to the amount of excess reserves
90
how are changes in currency holding related to money supply
the money supply is negatively related to currency holdings
91
how do changes in nonborrowed monetary base affect money supply
money supply is positively related to the nonborrowed monetary base MBn
92
how re changes in borrowed reserves from the fed related to money supply
money supply is positively related to the levels of borrowed reserves BR from the fed
93
Money Multiplier
money is currency plus checkable deposits (M1)
link the money supply (M) to the monetary base (MB) and let m be the money multplier
M=mxMR
94
what is the money multipler
M= (1+c)/(r+e+c)
c= currency
r=reserves
e=excess reserves
