Regulation and Monetary Policy pt2 Flashcards
Liquidity ratio
Ratio of the banks liquid assets to its deposits. They are used to asses a banks ability to meet short term obligations and maintain sufficient liquid assets to cover withdrawals and unexpected finding needs
Capital ratio
The amount of capital on a bank’s balance sheet as a proportion of its loans. Capital is the value of the banks assets minus its liabilities; it is therefore the worth of the bank.
Lending long and borrowing short
Liquidity can be a problem for banks because they tend to lend money over longer periods of time e.g. mortgages which takes years to pay off. The money they borrow in order to this is usually required to be available at short notice e.g. customer deposits.
Interbank lending
Helps banks collectively to resolve the “cashflow problem”, with the central bank as lender of last resort.
Basel III
A global, voluntary regulatory framework, strengthening capital and liquidity requirements on banks.
Causes of commercial bank failures
-Poor management-too much risk
-Lack of diversification e.g. excessive lending to volatile markets
-Insufficient reserves to cover bad loans
-Run on the bank-Too many depositors withdraw money at the same time
-Economic downturns
-Regulatory failure
Arguments for allowing banks to fail
-Encourages market discipline
-Promotes competition-Challenger banks can step in whereas bailouts makes the financial markets less contestable
-Avoids moral hazard
-Protects taxpayers
Justification of bank bailouts
-Preventing systematic risk
-Protecting depositors and reduces their risk of losing money
-Avoiding negative externalities from financial market failures.
Cash reserve ratio
Mandates that banks maintain a certain percentage of their total deposits in the form of cash or deposits with the central bank. Ratio is set by the central bank to ensure banks have liquid assets to meet immediate withdrawal demands from depositors.
