Term
| Main source of instability in financial markets? |
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Definition
1. Insolvent: Assets < Liabilities --can lead to bank run
2. Bank Run: depositors make complete and simultaneous withdrawels.
3. Illiquid: cannot meet cash withdrawel demands--bank failure |
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Term
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Definition
| - when the failure of one bank leads to the failure of others. |
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Term
| How can one bank's failure trigger a system-wide panic? |
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Definition
| - the belief of one banks failure can lead to concern of other banks to fail. |
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Term
| Why do banks get so much more attention from government regulators than other industries? |
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Definition
| Government wants to prevent contagion. |
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Term
2 main types of protection put in by the government
1. Lender of Last Resort
2. Deposit Insurance |
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Definition
1. Lender of Last Resort: the ultimate source of credit to banks during a panic. A role for the central bank.
- ensure that solvent banks can meet cash withdrawel demands even in a crisis. --reduce chance of contagion.
moral hazard- banks take on too much risk--must limit. |
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Term
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Definition
- guarentees that a depositor will receive the full account balance up to some maximum amount even if a bank fails
2 methods:-
Payoff: Assets sold, deposits refunded, bank closed.
Purchase and assumption: FDIC finds "buyer" for failing bank. Seemless transition. No deposits lost.
-means depositors are indifferent to the risk taken by the bank's managers.
creates moral hazard, banks are going to take on more risk. |
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Term
| 3 Strategies to minimize the moral hazard involved with the government safety net. |
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Definition
1. Government regulation: establishes specific rules for bank managers to follow
2. Government supervision: provides general oversight of financial institutions
3. Formal examination: of banks' books by specialists provides detailed info on the firms' operations |
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Term
| Restrictions/Regulations enforced by the government |
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Definition
-Asset holding restrictions: -cant hold stocks, or junk bonds. - no more than 25% of assets from individual issuer - less than 25% of capital in interbank loans - Ensures that safety net is not exploited
- Minimum cap requirements: -capital acts as buffer, has to be big enough - certain level of networth lowers moral hazard - hold assets proportional to riskiness of operations.
- Regular visits from examiner--also electronic monitoring
-check that loan collateral exists
-evaluate past due loans to see that banks write them off
-large banks under continous examination. |
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Term
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Definition
Used to rate banks
-Capital Adequency
- Asset quality -advice banks on how best to
- Management maximize profits while keeping
- Earnings risk at an acceptable level.
- Liquidity
- Sensitivity to risk |
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