VII. Regulation of the Financial System

Question 1

T or F. The financial system is among the most heavily regulated sectors of the American economy.

Answer 1

True

Question 2

The government regulates financial markets for three main reasons. What are those reasons?

Answer 2

1. to increase the information available to investors
2. to ensure the soundness of the financial system
3. to improve control of monetary policy

Question 2

Investors may be subject to adverse selection and moral hazard problems that may hinder the efficient operation of
financial markets.

Answer 2

Asymmetric information

Question 2

How does Increasing the amount of Information Available to Investors work?

Answer 2

By Increasing the amount of Information Available to Investors, Government regulation can reduce adverse selection and moral hazard problems in financial markets and increase their efficiency.

Question 3

What happened after the stock market crash in 1929 and revelations of widespread fraud in the aftermath?

Answer 3

There have been political demands for regulation culminated in the Securities Act of 1933 and the establishment of the Securities and Exchange Commission (SEC)

Question 3

T or F. The SEC requires corporations issuing securities to disclose certain information about their sales, assets, and
earnings to the public and restricts trading by the largest stockholders in the corporation.

Answer 3

True

Question 3

Asymmetric information can also lead to widespread collapse of financial intermediaries, referred to as a __________.

Answer 3

financial panic

Question 4

What happens during a financial panic?

Answer 4

It produces large losses for the public and causes serious damage to the economy.

Question 5

What are the 6 types of regulations that the government has implemented to protect the public and the economy from financial panics?

Answer 5

1. Restrictions on Entry
2. Disclosure
3. Restrictions on Assets and Activities
4. Deposit Insurance
5. Limits on Competition
6. Restrictions on Interest Rates

Question 6

How does Ensuring the Soundness of Financial Intermediaries work?

Answer 6

Because providers of funds to financial intermediaries may not be able to assess whether the institutions holding their funds are sound or not, if they have doubts about the overall health of financial intermediaries, they may want to
pull their funds out of both sound and unsound institutions, leading to financial panic. Hence the government implemented 6 types of regulations.

Question 7

This regulation consists of the State banking and insurance commissions, as well as the Office of the Comptroller of the Currency which have created very tight regulations governing who is allowed to set up a financial intermediary.

Answer 7

Restrictions to Entry

Question 8

T or F. Under the disclosure regulation, Individuals or groups that want to establish a financial intermediary, such as a bank or an insurance company, must obtain a charter from the state or the federal government.

Answer 8

False. It is under the Restrictions to Entry regulation

Question 9

What characteristics must one possess to be entitled to a charter (restrictions to entry)?

Answer 9

Only if they are upstanding citizens with impeccable credentials and a large amount of initial funds will they be given a charter.

Question 10

Explain how the disclosure regulation would work.

Answer 10

There would be stringent reporting requirements for financial intermediaries.

Question 11

What strict principles must the bookkeeping of disclosure regulation must follow?

Answer 11

their books are subject to periodic inspection, and they must make certain information available to the public.

Question 12

There are restrictions on what financial intermediaries are allowed to do and what assets they can hold. What regulation is this pertaining to?

Answer 12

Restrictions on Assets and Activities

Question 12

What are the ways to restrict a financial intermediary, to ensure that it will be able to meet its obligation to you?

Answer 12

• restrict the financial intermediary from engaging in certain risky activities.
• restrict financial intermediaries from holding certain risky assets, or at least from holding a greater quantity of these risky assets than is prudent.

Question 13

What regulation gives assurance that the government can insure people providing funds to a financial intermediary from any
financial loss if the financial intermediary should fail?

Answer 13

Deposit Insurance

Question 14

The most important government agency that provides this type of insurance is the _______________, which insures each depositor at a commercial bank or mutual savings bank up to a loss of ________ per account.

Answer 14

Federal Deposit Insurance Corporation
CFDIC); $100,000.

Question 15

Under this regulation, it is said that Politicians have often declared that unbridled competition among financial intermediaries promotes failures that will harm the public

Answer 15

Limits on Competition

Question 15

The Savings Association Insurance Fund (part of the FDIC) provides deposit insurance for _________, as to the National Credit Union Share Insurance Fund (NCUSIF) provides the same for________.

Answer 15

savings and loan associations; credit unions.

Question 16

Although the evidence that competition does this is extremely weak, it has not stopped the state and federal governments from imposing many restrictive regulations such as _____________.

Answer 16

restrictions on the opening of additional
locations (branches).

Question 17

How does Improving Control of Monetary Policy work?

Answer 17

Because banks play a very important role in determining the supply of money, much regulation of these financial
intermediaries are intended to improve control over the money supply.

Question 17

Competition has also been inhibited by regulations that impose _____________ that can be paid on deposits.

Answer 17

restrictions on interest rates

Question 17

T or F. . These regulations were instituted because of the widespread belief that
unrestricted interest-rate competition helped encourage bank failures during the Great Depression.

Answer 17

True.

Question 17

___________ is a regulation under the improvement of the control of monetary policy which makes it obligatory for all depository institutions to keep a
certain fraction of their deposits in accounts with the Federal Reserve System, the central bank in the United States, or as cash in their vaults.

Answer 17

reserve requirements

Question 18

T or F. Reserve requirements help
the Fed exercise more precise control over the money supply.

Answer 18

True