Deck 11: Economic Analysis of Financial Regulation

Question 1

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.

Answer 1

adverse selection problem.

Question 2

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.

Answer 2

forgiving tax debt.

Question 3

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 but no moral hazard problem.

Answer 3

provides increased incentives for risk taking.

Question 4

To prevent bank runs and the consequent bank failures,the United States established the ________ in 1934 to provide deposit insurance.

A)FDIC
B)SEC
C)Federal Reserve
D)ATM

Question 5

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

Question 6

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 7

In May 1991,the FDIC announced that it would sell the government's final 26% stake in Continental Illinois,ending government ownership of the bank that it had rescued in 1984.The FDIC took control of the bank,rather than liquidate it,because it believed that Continental Illinois

A)was a good investment opportunity for the government.
B)could be the Chicago branch of a new governmentally-owned interstate banking system.
C)was too big to fail.
D)would become the center of the new midwest region central bank system.

Question 8

During the boom years of the 1920s,bank failures were quite

A)uncommon,averaging less than 30 per year.
B)uncommon,averaging less than 100 per year.
C)common,averaging about 600 per year.
D)common,averaging about 1000 per year.

Question 9

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 10

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 11

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.

Question 12

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 13

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 14

Depositors lack of information about the quality of bank assets can lead to

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

Question 15

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

A)that the FDIC guarantees all deposits when it uses the "payoff" method.
B)that the FDIC guarantees all deposits when it uses the "purchase and assumption" method.
C)that the FDIC 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 FDIC 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 16

Although the FDIC 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 17

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 18

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 19

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 20

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.

Question 21

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 22

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 23

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

A)10%.
B)8%.
C)5%.
D)3%.

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

A bank failure is less likely to occur when

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

Question 26

The FDIC must take steps to close down banks whose equity capital is less than ________ of assets.

A)4%
B)3%
C)2%
D)1%

Question 27

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 28

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 29

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 30

If the FDIC 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 31

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

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

Question 32

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 33

Federal deposit insurance covers deposits up to $250,000,but as part of a doctrine called "too-big-to-fail" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system.When the FDIC does this,it uses the

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

Question 34

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 35

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 36

One of the criticisms of Basel 2 is that it is procyclical.That means that

A)banks may be required to hold more capital during times when capital is short.
B)banks may become professional at a cyclical response to economic conditions.
C)banks may be required to hold less capital during times when capital is short.
D)banks will not be required to hold capital during an expansion.

Question 37

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 38

A well-capitalized financial institution has ________ to lose if it fails and thus is ________ likely to pursue risky activities.

A)more; more
B)more; less
C)less; more
D)less; less

Question 39

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 40

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 41

The federal agencies that examine banks include

A)the Federal Reserve System.
B)the Internal Revenue Service.
C)the SEC.
D)the U.S.Treasury.

Question 42

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 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

Who has regulatory responsibility when a bank operates branches in many countries?

A)It is not always clear.
B)The WTO.
C)The U.S.Federal Reserve System.
D)The first country to submit an application.

Question 45

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 46

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 47

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 48

Microprudential supervision does all of the following except

A)checking capital ratios of a bank.
B)checking a bank's compliance with disclosure requirements.
C)assessing the riskiness of an individual bank's activities.
D)focusing on financial system liquidity.

Question 49

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 50

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 51

Microprudential supervision focuses on the safety and soundness of

A)individual financial institutions.
B)the financial system as a whole.
C)the shadow banking system.
D)government credit agencies.

Question 52

Consumer protection legislation includes legislation to

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

Question 53

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 54

Regulations that reduced competition between banks included

A)branching restrictions.
B)bank reserve requirements.
C)the dual system of granting bank charters.
D)interest-rate ceilings.

Question 55

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 56

Competition between banks

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

Question 57

Macroprudential supervision policies try to prevent a leverage cycle by changing capital requirements so that they ________ during an expansion and ________ during a downturn.

A)increase; decrease
B)increase; increase
C)decrease; increase
D)decrease; decrease

Question 58

The ________ that required separation of commercial and investment banking was repealed in 1999.

A)the Federal Reserve Act.
B)the Glass-Steagall Act.
C)the Bank Holding Company Act.
D)the Monetary Control Act.

Question 59

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 60

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 61

The Volcker Rule addresses the off-balance-sheet problem involving

A)trading risks.
B)selling loans.
C)loan guarantees.
D)interest rate risks.

Question 62

The collapse of the Bank of Credit and Commerce International,BCCI,showed the difficulty of international banking regulation.BCCI operated in more than ________ countries and was supervised by the small country of ________.

A)70,Luxembourg
B)100,Monaco
C)70,Monaco
D)100,Luxembourg

Question 63

Firms that are designated as systemically important financial institutions (SIFIs)are subject to all of the following additional Federal Reserve regulations except

A)higher capital standards.
B)stricter liquidity requirements.
C)providing a plan for orderly liquidation if necessary.
D)interest rate ceilings on time deposits.

Question 64

In the ten year period 1981-1990,1202 commercial banks were closed,with a peak of 206 failures in 1989.This rate of failures was approximately ________ times greater than that in the period from 1934 to 1980.

A)two
B)three
C)five
D)ten

Question 65

Prior to the 1980s,S&Ls and mutual savings banks were restricted almost entirely to

A)commercial real estate loans.
B)home mortgages.
C)education loans.
D)vacation loans.

Question 66

Banking crises have occurred throughout the world.What similarities do we find when we look at the different countries?

Question 67

A common element in all of the banking crisis episodes in different countries is

A)the existence of a government safety net.
B)deposit insurance.
C)increased regulation.
D)lack of competition.

Question 68

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

Question 69

All of the following are common to banking crises in different countries except

A)financial liberalization or innovation.
B)weak bank regulatory systems.
C)a government safety net.
D)a dual banking system.

Question 70

The Basel Committee ruled that regulators in other countries can ________ the operations of a foreign bank if they believe that it lacks effective oversight.

A)restrict
B)encourage
C)renegotiate
D)enhance

Question 71

The Depository Institutions Deregulation and Monetary Control Act of 1980

A)restricted thrift institutions to making loans for home mortgages.
B)restricted the use of ATS accounts.
C)imposed restrictive interest-rate ceilings on large agricultural loans.
D)increased deposit insurance from $40,000 to $100,000.

Question 72

Higher capital requirements will reduce the problems incurred when troubled ________ which had been off-balance sheet activities come back on the balance sheet.

A)structured investment vehicles (SIVs)
B)negotiable CDs
C)Eurodollars
D)Federal funds

Question 73

The Dodd-Frank legislation of 2010 permanently increased the federal deposit insurance to

A)$40,000.
B)$100,000.
C)$200,000.
D)$250,000.

Question 74

The new Consumer Financial Protection Bureau is an independent agency but is funded and housed within

A)the Treasury Department.
B)the Federal Reserve.
C)the SEC.
D)the IRS.

Question 75

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 76

In order to ensure that borrowers have an ability to repay residential mortgages,the new consumer protection legislation requires lenders to do all of the following except

A)verify the income of the borrower.
B)verify the borrower's job status.
C)check the credit history of the borrower.
D)verify that the borrower can read and understand a loan contract.

Question 77

During the 1960s,1970s,and early 1980s,traditional bank profitability declined because of

A)financial innovation that increased competition from new financial institutions.
B)a decrease in interest rates to fight the inflation problem.
C)a decrease in deposit insurance.
D)increased regulation that prohibited banks from making risky real estate loans.

Question 78

How did the increase in the interest rates in the early 80s contribute to the S&L crisis?

Question 79

Moral hazard problems increased in prominence in the 1980s

A)as deregulation required savings and loans and mutual savings banks to be more cautious.
B)following a burst of financial innovation in the 1970s and early 1980s that produced new financial instruments and markets,thereby widening the scope for risk taking.
C)following a decrease in federal deposit insurance from $100,000 to $40,000.
D)as interest rates were sharply decreased to bring down inflation.

Question 80

The evidence from banking crises in other countries indicates that

A)deposit insurance is to blame in each country.
B)a government safety net for depositors need not increase moral hazard.
C)regulatory forbearance never leads to problems.
D)deregulation combined with poor regulatory supervision raises moral hazard incentives.