Deck 9: Economic Analysis of Financial Regulation

Question 1

Since depositors, like any lender, only receive fixed payments while the bank keeps any surplus profits, they face the ________ problem that banks may take on too ________ risk.

A) adverse selection; little
B) adverse selection; much
C) moral hazard; little
D) moral hazard; much

Answer 1

D

Question 2

Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the ________.

A) too-big-to-fail effect
B) moral hazard problem
C) adverse selection problem
D) contagion effect

Answer 2

D

Question 3

The contagion effect refers to the fact that ________.

A) deposit insurance has eliminated the problem of bank failures
B) bank runs involve only sound banks
C) bank runs involve only insolvent banks
D) the failure of one bank can hasten the failure of other banks

Answer 3

D

Question 4

The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is ________.

A) that the CDIC guarantees all deposits when it uses the "payoff" method
B) that the CDIC guarantees all deposits when it uses the "purchase and assumption" method
C) that the CDIC is more likely to use the "payoff" method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures
D) that the CDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions

Question 5

Although the CDIC was created to prevent bank failures, its existence encourages banks to ________.

A) take too much risk
B) hold too much capital
C) open too many branches
D) buy too much stock

Question 6

Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a ________.

A) last-in, first-out constraint
B) sequential service constraint
C) double-coincidence of wants constraint
D) everyone-shares-equally constraint

Question 7

When the CDIC takes control of the bank, rather than liquidate it, it believes that the takeover ________.

A) was a good investment opportunity for the government
B) could be part of a new governmentally owned banking system
C) was too big to fail
D) would become the center of the new central bank system

Question 8

The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance ________.

A) are likely to take on greater risks than they otherwise would
B) are likely to be too conservative, reducing the probability of turning a profit
C) are likely to regard deposits as an unattractive source of funds due to depositors' demands for safety
D) are placed at a competitive disadvantage in acquiring funds

Question 9

When depositors lack of information about the quality of bank assets it can lead to ________.

A) bank panics
B) bank booms
C) sequencing
D) asset transformation

Question 10

Moral hazard is an important concern of insurance arrangements because the existence of insurance ________.

A) provides increased incentives for risk taking
B) is a hindrance to efficient risk taking
C) causes the private cost of the insured activity to increase
D) creates an adverse selection problem

Question 11

Deposit insurance is a guarantee by the CDIC to pay deposits off in full on the first ________ they have deposited in the bank.

A) $60000
B) $200,000
C) $100,000
D) $150,000

Question 12

To prevent bank runs and the consequent bank failures, the Canada established the ________ to provide deposit insurance.

A) CDIC
B) OSC
C) Bank of Canada
D) ATM

Question 13

The fact that banks operate on a "sequential service constraint" means that ________.

A) all depositors share equally in the bank's funds during a crisis
B) depositors arriving last are just as likely to receive their funds as those arriving first
C) depositors arriving first have the best chance of withdrawing their funds
D) banks randomly select the depositors who will receive all of their funds

Question 14

When bad drivers line up to purchase collision insurance, automobile insurers are subject to the ________.

A) moral hazard problem
B) adverse selection problem
C) assigned risk problem
D) ill queue problem

Question 15

Deposit insurance covers deposits up to $100,000, but as part of a doctrine called "too-big-to-fail" the CDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the CDIC does this, it uses the ________.

A) "payoff" method
B) "purchase and assumption" method
C) "inequity" method
D) "Basel" method

Question 16

A system of deposit insurance ________.

A) attracts risk-taking entrepreneurs into the banking industry
B) encourages bank managers to decrease risk
C) increases the incentives of depositors to monitor the riskiness of their bank's asset portfolio
D) increases the likelihood of bank runs

Question 17

The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry.

A) an adverse selection
B) a moral hazard
C) a lemons
D) a revenue

Question 18

When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of ________.

A) moral hazard
B) split incentives
C) ex ante shirking
D) pre-contractual opportunism

Question 19

Deposit insurance has not worked well in countries with ________.

A) a weak institutional environment
B) strong supervision and regulation
C) a tradition of the rule of law
D) few opportunities for corruption

Question 20

Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions except ________.

A) forgiving tax debt
B) lending from the central bank
C) lending directly from the government's treasury department
D) nationalizing and guaranteeing that all creditors will be repaid their loans in full

Question 21

Banks engage in regulatory arbitrage by ________.

A) keeping high-risk assets on their books while removing low-risk assets with the same capital requirement
B) keeping low-risk assets on their books while removing high-risk assets with the same capital requirement
C) hiding risky assets from regulators
D) buying risky assets from arbitragers

Question 22

Off-balance-sheet activities ________.

A) generate fee income with no increase in risk
B) increase bank risk but do not increase income
C) generate fee income but increase a bank's risk
D) generate fee income and reduce risk

Question 23

If the CDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses.

A) payoff; large
B) payoff; no
C) purchase and assumption; large
D) purchase and assumption; no

Question 24

The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same capital requirement is known as ________.

A) competition in laxity
B) depositor supervision
C) regulatory arbitrage
D) a dual banking system

Question 25

The Basel Accord, an international agreement, requires banks to hold capital based on ________.

A) risk-weighted assets
B) the total value of assets
C) liabilities
D) deposits

Question 26

Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in ________.

A) reduced risk taking by banks
B) reduced supervision of banks by regulators
C) increased fraudulent behavior by banks
D) increased risk taking by banks

Question 27

The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.

Question 28

Regulators attempt to reduce the riskiness of banks' asset portfolios by ________.

A) limiting the amount of loans in particular categories or to individual borrowers
B) encouraging banks to hold risky assets such as common stocks
C) establishing a minimum interest rate floor that banks can earn on certain assets
D) requiring collateral for all loans

Question 29

A bank failure is less likely to occur when ________.

A) a bank holds less government securities
B) a bank suffers large deposit outflows
C) a bank holds fewer excess reserves
D) a bank has more bank capital

Question 30

The Basel Accord requires banks to hold as capital an amount that is at least ________ of their risk-weighted assets.

A) 10 percent
B) 8 percent
C) 5 percent
D) 3 percent

Question 31

The too-big-to-fail policy ________.

A) reduces moral hazard problems
B) puts large banks at a competitive disadvantage in attracting large deposits
C) treats large depositors of small banks inequitably when compared to depositors of large banks
D) allows small banks to take on more risk than large banks

Question 32

A problem with the too-big-to-fail policy is that it ________ the incentives for ________ by big banks.

A) increases; moral hazard
B) decreases; moral hazard
C) decreases; adverse selection
D) increases; adverse selection

Question 33

The leverage ratio is the ratio of a bank's ________.

A) assets divided by its liabilities
B) income divided by its assets
C) capital divided by its total assets
D) capital divided by its total liabilities

Question 34

To be considered well capitalized, a bank's leverage ratio must exceed ________.

A) 10 percent
B) 8 percent
C) 5 percent
D) 3 percent

Question 35

Under the Basel Accord, assets and off-balance sheet activities were sorted according to ________ categories with each category assigned a different weight to reflect the amount of ________.

A) 2; adverse selection
B) 2; credit risk
C) 4; adverse selection
D) 4; credit risk

Question 36

The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely.

A) small; fewer
B) small; greater
C) big; fewer
D) big; greater

Question 37

The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem.

A) adverse selection; adverse selection
B) adverse selection; moral hazard
C) moral hazard; adverse selection
D) moral hazard; moral hazard

Question 38

Acquiring information on a bank's activities in order to determine a bank's risk is difficult for depositors and is another argument for government ________.

A) regulation
B) ownership
C) recall
D) forbearance

Question 39

Agreements such as the ________ are attempts to standardize international banking regulations.

A) Basel Accord
B) UN Bank Accord
C) GATT Accord
D) WTO Accord

Question 40

Overseeing who operates banks and how they are operated is called ________.

A) prudential supervision
B) hazard insurance
C) regulatory interference
D) loan loss reserves

Question 41

The CDIC does not insure ________.

A) savings and chequing accounts
B) term deposits with a maturity of less than 5 years
C) money orders and drafts
D) mutual funds

Question 42

During times of financial crisis, mark-to-market accounting ________.

A) requires that a financial firms' assets be marked down in value which can worsen the lending crisis
B) leads to an increase in the financial firms' balance sheets since they can now get assets at bargain prices
C) leads to an increase in financial firms' lending
D) results in financial firms' assets increasing in value

Question 43

Regulations designed to provide information to the marketplace so that investors can make informed decisions are called ________.

A) disclosure requirements
B) efficient market requirements
C) asset restrictions
D) capital requirements

Question 44

The primary rationale for deposit insurance is ________.

A) protecting depositors from bank insolvency
B) increasing creditworthiness of subprime mortgages
C) increasing barriers to entry in the banking industry to promote financial stability
D) altering risk profiles of both banks and depositors

Question 45

The current supervisory practice toward risk management ________.

A) focuses on the quality of a bank's balance sheet
B) determines whether capital requirements have been met
C) evaluates the soundness of a bank's risk-management process
D) focuses on eliminating all risk

Question 46

Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth.

A) call reports
B) balance reports
C) regulatory sheets
D) examiner updates

Question 47

Which of the following is not a reason financial regulation and supervision is difficult in real life?

A) Financial institutions have strong incentives to avoid existing regulations
B) Unintended consequences may happen if details in the regulations are not precise
C) Regulated firms lobby politicians to lean on regulators to ease the rules
D) Financial institutions are not required to follow the rules

Question 48

What is the "too-big-to-fail" policy of the CDIC? how is it associated with asymmetric information problems?

Question 49

An important factor in producing the subprime mortgage crisis was ________.

A) lax consumer protection regulation
B) onerous rules placed on mortgage originators
C) weak incentives for mortgage brokers to use complicated mortgage products
D) strong incentives for the mortgage brokers to verify income information

Question 50

The chartering process is similar to ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets.

A) screening; restrictive covenants
B) screening; branching restrictions
C) identifying; branching restrictions
D) identifying; credit rationing

Question 51

Consumer protection legislation includes legislation to ________.

A) require banks to make loans to everyone who applies
B) reduce the amount of interest that bank's can charge on loans
C) require banks to make periodic reports to the Better Business Bureau
D) reduce discrimination in credit markets

Question 52

Banking regulation suffers from the principal-agent problem. Describe how this problem relates to regulators and politicians.

Question 53

Competition between banks ________.

A) encourages conservative bank management
B) increases bank profitability
C) encourages greater risk taking
D) eliminates the need for government regulation

Question 54

The ________ allowed chartered banks to own investment banking subsidiaries.

A) Bank of Canada Act
B) Financial Institutions and Deposit Insurance System Amendment Act
C) Bank Holding Company Act
D) Monetary Control Act

Question 55

What are the three pillars that Basel 2 is based on?

Question 56

The CDIC does not insure term deposits with an initial maturity date of more than ________.

A) 5 years
B) 2 years
C) 1 year
D) 90 days

Question 57

Bank examiners include ________.

A) the Bank of Canada
B) Canada Revenue Agency
C) the OSC
D) the Department of Finance

Question 58

Banks will be examined at least once a year and given a CAMELS rating by examiners. The L stands for ________.

A) liabilities
B) liquidity
C) loans
D) leverage

Question 59

With ________, firms value assets on their balance sheet at what they would sell for in the market.

A) mark-to-market accounting
B) book-value accounting
C) historical-cost accounting
D) off-balance sheet accounting

Question 60

Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry.

A) moral hazard
B) adverse selection
C) ex post shirking
D) post-contractual opportunism

Question 61

The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 2 was ________.

A) 3 percent
B) 6.5 percent
C) 13.0 percent
D) 26.0 percent

Question 62

The Bank of Credit and Commerce International (BCCI) operated in ________ countries prior to its collapse.

A) 70
B) 5
C) 70
D) 50

Question 63

According to CDIC risk profiles, ________.

A) group 1 is the best and group 4 is the worst
B) group 4 is the best and group 1 is the worst
C) all banks are considered to be similar
D) there is no way to distinguish between them

Question 64

The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 4 was ________.

A) 3 percent
B) 6.5 percent
C) 13.0 percent
D) 33.33 percent

Question 65

The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 3 was ________.

A) 3 percent
B) 6.5 percent
C) 13.0 percent
D) 26.0 percent

Question 66

Sometimes regulators refrain from putting insolvent banks out of business. This is also known as ________.

A) a decrease in deposit insurance
B) a decrease in interest rates to fight the inflation problem
C) regulatory forbearance
D) increased regulation that prohibited banks from making risky loans

Question 67

Describe how the CDIC premiums have evolved over the past years.

Question 68

In the mid-1980s, how many chartered banks failed in Canada?

A) Two
B) Three
C) Five
D) Ten

Question 69

One of the reasons for the failure of Canadian Commercial and Northland banks was ________.

A) moral hazard
B) adverse selection
C) the lack of deposit insurance
D) rising oil prices

Question 70

The Differential Premiums By-law came into effect for the premium year beginning ________.

A) May 1, 1999
B) January 1, 1999
C) May 31, 1999
D) December 31, 1999

Question 71

The Differential Premiums By-law classifies CDIC institutions according to their risk profile. ________ dominate the criteria.

A) Capital adequacy measures
B) Quantitative aspects
C) Qualitative aspects
D) CAMELS rating

Question 72

CDIC premium revenue is ________.

A) the same for all deposit taking institutions
B) vary from 15 cents to 20 cents per dollar
C) based on the risk profile of the member institution
D) capped at 15 cents for "worst" institutions

Question 73

The Basel Committee ruled that regulators in other countries could ________ of a foreign bank if they feel that it lacks effective oversight.

A) restrict operations
B) ban operations
C) takeover
D) merge operations

Question 74

Banking reform possibilities include ________.

A) coinsurance
B) bank mergers
C) reduced capitalization requirements
D) reducing the scope of deposit insurance

Question 75

The MacKay Task Force may recommend that the ________.

A) OFSI and CDIC be amalgamated
B) CDIC be abolished
C) Standards of Sound Business Practices be implemented
D) OFSI and CDIC should be separated

Question 76

Deposit co-insurance requires that ________.

A) only a percentage of a deposit would be covered by insurance
B) the amount of deposits covered by insurance would be lowered
C) there be joint insurance from both bankers and depositors
D) both the federal and provincial governments provide deposit insurance

Question 77

The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 1 was ________.

A) 3 percent
B) 6.5 percent
C) 13.0 percent
D) 26.0 percent

Question 78

The Inspector General of Banks was the predecessor of the ________.

A) Office of the Superintendent of Financial Institutions
B) Office of Regulatory Forbearance
C) Canadian Commercial Regulatory Committee
D) Basel Committee

Question 79

What are the provisions under the October 15, 1999 Opting-Out By-law?

Question 80

In the 1998-1999 fiscal year, the flat rate insurance premium was ________.

A) 1/6 of 1 percent
B) 1/4 of 1 percent
C) 1/3 of 1 percent
D) 1/2 of 1 percent