Deck 14: Regulating the Financial System

Question 1

When healthy banks fail due to widespread bank panics, those who are likely to be hurt are:

A)government regulators.
B)households and small businesses.
C)the FDIC.
D)the Federal Reserve.

Answer 1

B

Question 2

The financial system is inherently more unstable than most other industries due to the fact that:

A)while in most other industries customers disappear at a faster rate, in banking they disappear slowly so the damage is done before the real problem is identified.
B)banks deal in paper profits, not in real profits.
C)a single firm failing in banking can bring down the entire system; this isn't true in most other industries.
D)there is less competition than in other industries.

Answer 2

C

Question 3

The government regulates bank mergers, sometimes denying the proposed merger.Often the reason given for the denial is to protect small investors.What are small investors being protected from?

A)with a larger bank the bank is likely to take greater risk and may fail.
B)in order to pay for the merger, the bank may seek higher returns putting the depositors' funds at greater risk.
C)mergers can increase the monopoly power of banks and the bank may seek to exploit this power by raising prices and earning unwarranted profits.
D)bank runs hurt larger banks more than smaller banks.

Answer 3

C

Question 4

The reasons for the government to get involved in the financial system include each of the following, except:

A)to protect the bank's monopoly position.
B)to protect investors.
C)to ensure the stability of the financial system.
D)to protect bank customers from monopolistic exploitation.

Question 5

Contagion is:

A)the failure of one bank spreading to other banks through depositors withdrawing of funds.
B)the phenomenon that if one bank loan defaults it will cause other bank loans to default.
C)the rapid contraction of investment spending that occurs when interest rates are increased by the Federal Reserve.
D)the rapid inflation that results from the printing of money.

Question 6

The reason that a run on a single bank can turn into a bank panic that threatens the entire financial system is:

A)information asymmetries.
B)moral hazard.
C)the lack of regulation.
D)the increased reliance on web-based funds transfers.

Question 7

Recession can cause widespread bank crises for all of the following reasons except:

A)there is less business investment as banks make fewer loans.
B)borrowers' default rates increase.
C)bank capital increases.
D)the negative effect on banks' balance sheets.

Question 8

Bank panics have often begun as a result of:

A)rumors only.
B)real economic events only.
C)both rumors and real economic events.
D)neither rumors nor economic events.

Question 9

What matters most during a bank run is:

A)the number of loans outstanding.
B)the solvency of the bank.
C)the liquidity of the bank.
D)the size of the bank's assets.

Question 10

It is difficult for depositors to know the true health of banks because:

A)regulations prohibit banks making their financial statements publicly available.
B)the financial statements of banks are too difficult for most people to understand.
C)most of the information on bank loans is private and based on sophisticated models.
D)banking is competitive and financial records of banks are not divulged to prevent competitor banks from having an advantage.

Question 11

An economic rationale for government protection of small investors is that:

A)large investors can better afford losses.
B)many small investors cannot adequately judge the soundness of their bank.
C)there is inadequate competition to ensure a bank is operating efficiently.
D)banks are often run by unethical managers who will often exploit small investors.

Question 12

The government provides deposit insurance; this insurance protects:

A)large corporate deposit accounts, but only the amounts that exceed the $250,000 deductible.
B)depositors for up to $250,000 should a bank fail.
C)the deposits of banks in their Federal Reserve accounts.
D)the deposits that people have, but only for federally chartered banks.

Question 13

The government's providing of deposit insurance and functioning as the lender of last resort has significantly:

A)decreased the incentive for bank managers to take on risk.
B)increased the amount of regulation of banks required, but has had no effect on bank's incentive to take on risk.
C)increased the incentive for banks to take on risk, but has had no effect on the amount of regulation of banks required.
D)increased the amount of regulation of banks required and increased the incentive for banks to take on risk.

Question 14

Rumors of a bank failing, even if not true, can become a self-fulfilling prophecy because:

A)customers will not want to obtain loans from this bank.
B)equity investors will not be able to sell the bank's stock.
C)regulators will scrutinize the bank heavily looking for something wrong.
D)depositors will rush to the bank to withdraw their deposits and the bank under normal situations would not have sufficient liquid assets on hand.

Question 15

Empirical evidence points to the fact that financial crises:

A)are newsworthy but have no impact on economic growth.
B)have a negative impact on economic growth only for the year of the crisis.
C)have a negative impact on economic growth for years.
D)can have a positive impact on economic growth as weak borrowers are weeded out.

Question 16

The federal government is concerned about the health of the banking system for many reasons, the most important of which may be:

A)banks are where government bonds are traded.
B)a significant number of people are employed in the banking industry.
C)many people earn the majority of their income from interest on bank deposits.
D)banks are of great importance in enabling the economy to operate efficiently.

Question 17

Deflation can cause widespread bank crises for all of the following reasons except:

A)a decline in the value of borrowers' net worth but not their liabilities.
B)borrowers' default rates increase.
C)bank balance sheets deteriorate as the level of economic activity decreases.
D)information asymmetry problems decrease during deflationary periods.

Question 18

A bank run involves:

A)illegal activities on the part of the bank's officers.
B)a bank being forced into bankruptcy.
C)a large number of depositors withdrawing their funds during a short time span.
D)a bank's return on assets being below the acceptable level.

Question 19

Bank failures tend to occur most often during periods of:

A)stock market run ups when, like many companies, banks tend to be overvalued.
B)high inflation when the fixed rate loans of many banks cause their real returns to decrease.
C)recessions when many borrowers have a difficult time repaying loans and lending activity slows.
D)wars and other civil unrest.

Question 20

The government's role of lender of last resort is directed to:

A)large manufacturing firms that employ thousands of people.
B)depositors; this is role the government plays when they insure depositors' balances in banks that fail.
C)developing countries that are trying to build their financial systems.
D)banks that experience sudden deposit outflows.

Question 21

During the financial crisis of 2007-2009 in the United States it was revealed that the function of a lender of last resort had not kept pace with the evolving financial system because:

A)financial intermediaries had grown sufficiently large so as not to need a lender of last resort.
B)shadow banks lacked access to the financial resources available through the lender of last resort.
C)banks were sufficiently linked to one another that the need for a lender of last resort had diminished.
D)banks had become sufficiently diversified so as to be able to provide for their own liquidity.

Question 22

One of the unique problems that banks face is:

A)they hold liquid assets to meet illiquid liabilities.
B)they hold illiquid assets to meet liquid liabilities.
C)they hold liquid assets to meet liquid liabilities.
D)both their assets and their liabilities are illiquid.

Question 23

If the lender of last resort function of the government is to be effective in working to minimize a crisis, it must be:

A)reserved only for those banks that are most deserving.
B)used on a limited basis.
C)credible, with banks knowing they can get loans quickly.
D)only available during economic downturns.

Question 24

On November 20, 1985, the Bank of New York needed to use the lender of last resort function due to:

A)a run on the bank started by a rumor that the president of the bank embezzled tens of millions of dollars from the bank.
B)a computer error caused the bank's records to wipe out the balances of all of its customers.
C)a rumor that the bank was about to be taken over by FDIC due to insolvency.
D)a computer error that made it impossible for the bank to keep track of its Treasury bond trades.

Question 25

The creation of the Federal Reserve in 1913:

A)provided the opportunity for lender of last resort but not the guarantee that it would be used.
B)guaranteed the Federal Reserve would always act as lender of last resort.
C)eliminated bank panics in the U.S.
D)was in response to the Great Depression in the U.S.

Question 26

The need for a lender of last resort was identified as far back as:

A)the start of the Great Depression in 1929.
B)1913, when the Federal Reserve was created.
C)1873, by British economist Walter Bagehot.
D)1776, by the first U.S.Secretary of the Treasury, Alexander Hamilton.

Question 27

The inter-bank loans that appear on banks' balance sheets represent what proportion of bank capital?

A)Nearly ten percent
B)Almost three-fourths
C)About one-third
D)Less than one percent

Question 28

During a bank crisis:

A)officials at the Federal Reserve find it easy to sort out solvent from insolvent banks.
B)it is important for regulators to be able to distinguish insolvent from illiquid banks.
C)it is easy to determine the market prices of bank's assets.
D)a bank will go to the central bank for a loan before going to other banks.

Question 29

If your stockbroker gives you bad advice and you lose your investment:

A)the government will reimburse you similar to reimbursing depositors if a bank fails.
B)the government will not reimburse you for the loss; you are not protected from bad advice by your stockbroker.
C)these losses would be covered under FDIC insurance.
D)your investment would only be covered if the stockbroker was employed by a bank.

Question 30

Considering the methods available to the FDIC for dealing with a failed bank, the depositors of the failed bank should:

A)be indifferent between the two since it really does not matter to them which method is used.
B)prefer the purchase and assumption method since the deposits over $250,000 will also be protected.
C)prefer the payoff method because they will have access to their funds earlier.
D)prefer the payoff method since a lot less paperwork is involved for the depositor.

Question 31

The existence of a lender of last resort creates moral hazard for bank managers because:

A)they have an incentive to take too much risk in their operations.
B)officials are likely to undervalue the bank's portfolio of assets.
C)they are less likely to apply for a direct loan from the central bank.
D)banks seek loans from the central bank only after exploring other options.

Question 32

A moral hazard situation arises in the lender of last resort function because:

A)a central bank finds it difficult to distinguish illiquid from insolvent banks.
B)a central bank usually will only make a loan to a bank after it becomes insolvent.
C)a central bank usually undervalues the assets of a bank in a crisis.
D)the central bank is the first place a bank facing a crisis will turn.

Question 33

The payoff method used by the FDIC to address the insolvency of a bank is when the FDIC:

A)pays the owners of the bank for the losses they would otherwise face.
B)pays off all depositors the balances in their accounts so no depositor suffers a loss, though the owners of the bank may suffer losses.
C)pays off the depositors up to the current $250,000 limit, so it is possible that some depositors will suffer losses.
D)takes all of the assets of the bank, sells them, pays off the liabilities of the bank, in full and then replenishes their fund with any remaining balance.

Question 34

When the Federal Reserve was unable to stem the bank panics of the 1930s, Congress responded by:

A)taking over the lender of last resort function and assigning this function to the U.S.Treasury.
B)ordering the printing of tens of billions of dollars of additional currency.
C)creating the FDIC and offering deposit insurance.
D)declaring a bank holiday and closing banks for 30 days.

Question 35

Under the purchase-and-assumption method, the FDIC usually finds it:

A)can sell the failed bank for more than the bank is actually worth.
B)can sell the bank at a price equaling the value of the failed banks assets.
C)has to sell the bank at a negative price since the bank is insolvent.
D)cannot sell the bank and almost always has to revert to the payoff method for dealing with a failed bank.

Question 36

One reason customers do not care about the quality of their bank's assets is:

A)most people cannot distinguish an asset from a liability.
B)the quality of a bank's assets changes almost daily.
C)they assume the bank only has high quality assets.
D)with deposit insurance, there isn't any real reason to care; their deposits are protected even if the bank fails.

Question 37

Under the purchase-and-assumption method of dealing with a failed bank, the FDIC:

A)finds another bank to take over the insolvent bank.
B)takes over the day to day management of the bank.
C)sells the failed bank to the Federal Reserve.
D)sells off the profitable loans of the failed bank in an open auction.

Question 38

The first test of the Federal Reserve as lender of last resort occurred with the:

A)attack on Pearl Harbor by the Japanese.
B)widespread failures of Savings and Loans in the 1980's.
C)introduction of flexible exchange rates in the U.S.in 1971.
D)stock market crash in 1929.

Question 39

One lesson learned from the bank panics of the early 1930's is:

A)the lender of last resort function almost guarantees that bank panics are a thing of the past.
B)the mere existence of a lender of last resort will not keep the financial system from collapsing.
C)only the U.S.Treasury can be a true lender of last resort.
D)the financial system will collapse without a lender of last resort.

Question 40

The best way for a government to stop the failure of one bank from turning into a bank panic is to:

A)make sure solvent institutions can meet the withdrawal demands of depositors.
B)declare a bank holiday until solvent banks can acquire adequate liquidity.
C)limit the withdrawals of depositors.
D)provide zero-interest rate loans to all banks regardless of net worth.

Question 41

Which of the following regulates commercial banks as well as savings banks and savings and loans?

A)The Federal Reserve System
B)Securities and Exchange Commission
C)The Office of the Comptroller of the Currency
D)The Internal Revenue Service

Question 42

The fact that banks can be either nationally or state chartered creates:

A)situations where some banks go unregulated.
B)situations where banks operating in more than one state can escape regulation.
C)regulatory competition.
D)banks being simultaneously regulated by more than one agency.

Question 43

If the government did not offer the too-big-to-fail safety net:

A)large banks would be more disciplined by the potential loss of large corporate accounts.
B)the moral hazard problem of insuring large banks would increase.
C)the moral hazard problem of insuring large banks would not be affected.
D)the FDIC deposit insurance limits would have to be raised.

Question 44

Savings banks and savings and loans are regulated by a combination of agencies which includes all of the following except:

A)The Federal Reserve System.
B)The Comptroller of the Currency.
C)The Federal Deposit Insurance Corporation.
D)state authorities.

Question 45

Governments employ three strategies to contain the risks created by government safety nets.These include each of the following, except:

A)government supervision.
B)an excise tax on bank profits.
C)government regulation.
D)formal bank examination.

Question 46

The moral hazard problem caused by government safety nets:

A)is greater for larger banks.
B)is greater for smaller banks.
C)is pretty constant across banks of all sizes.
D)only exists for banks with high leverage ratios.

Question 47

Savings banks and savings and loans are regulated by a combination of agencies which includes the:

A)Federal Reserve System.
B)Office of the Comptroller of the Currency.
C)Securities and Exchange Commission.
D)Internal Revenue Service.

Question 48

As a result of government provided deposit insurance, the ratio of assets to capital for commercial banks since the 1920s has:

A)just about doubled.
B)almost tripled.
C)not changed.
D)decreased.

Question 49

Implicit government support for "too big to fail" banks:

A)increases the scrutiny of the bank's risk by large corporate depositors.
B)reduces the risk faced by depositors with accounts less than $250,000.
C)reduces the risk faced by depositors with accounts exceeding $250,000.
D)reduces the moral hazard problem of insuring large banks.

Question 50

Since the 1920's, the ratio of assets to capital has almost tripled for commercial banks.Many economists believe this is the direct result of:

A)lower quality management in banks.
B)the increase in branch banking.
C)allowing banks to offer non-bank services.
D)government provided deposit insurance.

Question 51

Credit Unions are regulated by a combination of agencies which includes:

A)state authorities.
B)The Federal Reserve.
C)The Federal Deposit Insurance Corporation.
D)The Office of the Comptroller of the Currency.

Question 52

The purpose of the government's safety net for banks is to do each of the following, except:

A)protect the integrity of the financial system.
B)eliminate all risk that investors face.
C)stop bank panics.
D)improve the efficiency of the economy.

Question 53

In the ten years after the FDIC limit was increased to $100,000:

A)more than four times the number of banks and savings and loans failed than did during the first 46 years of FDIC's existence.
B)less than one-fourth the number of banks and savings and loans failed than during the first 46 years of FDIC's existence.
C)the cost to taxpayers of failed institutions in that period was negligible because FDIC was in place.
D)increasing the deposit insurance limit to $250,000 provided complete coverage for all deposits except those of large corporations.

Question 54

Deposit insurance only seems to be viable at the federal level.This is likely due to the fact that:

A)state funds are less informed about the solvency of national banks.
B)a run on the banks within a state will always spread countrywide.
C)the U.S.Treasury backs the FDIC and can therefore withstand virtually any crisis.
D)the cost of state insurance is prohibitively high.

Question 55

Many states had their own insurance fund to protect depositors.The critical problem with these state funds is:

A)they are monopolies in their own state and extract extremely high prices for the insurance they provide.
B)they are highly inefficient they cannot achieve the economies of scale a federal fund can achieve.
C)they do not have regulators as knowledgeable as the regulators at FDIC.
D)no state fund is large enough to withstand a run on all of the banks it insures.

Question 56

Banks can effectively choose their regulators by deciding whether to:

A)be a private or public corporation.
B)be a member of the Federal Reserve or not.
C)purchase FDIC insurance or to forego the coverage.
D)be chartered at the national or state level.

Question 57

Governments supervise banks mainly to do each of the following, except:

A)reduce the potential cost to taxpayers of bank failures.
B)be sure the banks are following the regulations set out by banking laws.
C)reduce the moral hazard risk.
D)eliminate all risk faced by investors.

Question 58

Which of the following statements is most correct?

A)the higher the deposit insurance limit the lower the risk of moral hazard.
B)the higher the deposit insurance limit the greater the risk of moral hazard.
C)deposit insurance limits do not impact moral hazard, they impact adverse selection.
D)increasing the deposit insurance limits above $100,000 would increase coverage for over 50 percent of all depositors.

Question 59

One negative consequence of regulatory competition is:

A)it is expensive.
B)financial institutions are over regulated at a cost to customers.
C)financial institutions often seek out the most lenient regulator.
D)it minimizes competition.

Question 60

The government's too-big-to-fail policy applies to:

A)certain highly populated states where a bank run impacts a large percent of the total population.
B)large banks whose failure would start a widespread panic in the financial system.
C)large corporate payroll accounts held by some banks where many people would lose their income.
D)banks that have branches in more than two states.

Question 61

Banking regulations prevent banks from:

A)holding more than 10 percent of their assets in common stock of companies.
B)owning corporate jets.
C)owning common stocks of corporations.
D)building big office buildings.

Question 62

You have savings accounts at two separately FDIC insured banks.At one of the banks your account has a balance of $200,000.At the other bank the account balance is $60,000.If both banks fail, you will receive:

A)$250,000.
B)$60,000.
C)$260,000.
D)$200,000.

Question 63

The acronym CAMELS, which is the criteria used by supervisors to evaluate the health of banks, includes the following, except:

A)asset quality.
B)losses.
C)management.
D)earnings.

Question 64

The CAMELS ratings are:

A)made public monthly to the financial markets so people can judge the relative quality of banks.
B)published once a quarter in banking journals issued by the Federal Reserve.
C)included in the annual report of publicly owned banks.
D)not made public.

Question 65

Prior to the financial crisis of 2007-2009 banks did all but which of the following to bulk up their profit:

A)bought or sponsored hedge funds.
B)traded securities for customers.
C)purchased equities for their own account.
D)colluded to fix benchmark interest rates.

Question 66

You hold an FDIC insured savings account at your neighborhood bank.Your current balance is $275,000.If the bank fails you will receive:

A)$275,000.
B)$250,000.
C)$100,000.
D)$125,000.

Question 67

Following the consolidation that resulted from the 2007-2009 financial crisis in the U.S., the 4 largest commercial banks share of total deposits was:

A)75%.
B)50%.
C)40%.
D)25%.

Question 68

Banks are required to disclose certain information.This disclosure is done for all of the following reasons except:

A)to enable regulators to more easily assess the financial condition of banks.
B)to allow financial market participants to penalize banks that carry additional risk.
C)to allow customers to more easily compare prices for services offered by banks.
D)create uniform prices for standard bank services.

Question 69

Which of the following is not a pillar of the latest Basel Accord?

A)A revised set of minimum capital requirements
B)It includes liquidity requirements in addition to capital requirements
C)It supplements capital requirements based on risk-weighted assets with restrictions on leverage
D)Uniform international laws for bank regulation

Question 70

The original Basel Accord was:

A)the basic set of guidelines the Federal Reserve applies in regulating domestic banks.
B)a set of guidelines for basic capital requirements for internationally active banks.
C)an agreement between state and federal regulators to try to have one standard set of guidelines for all banks.
D)a set of guidelines applied only to international banks operating with U.S.boundaries.

Question 71

A long-standing goal of financial regulators has been to:

A)prevent banks from growing too big and powerful.
B)minimize the competition that banks face.
C)encourage banks to grow as large as possible.
D)discourage small rural banks.

Question 72

Which of the following statements is most correct?

A)Financial regulators do everything possible to encourage competition in banking.
B)Financial regulators work to prevent monopolies but also work to prevent strong competition in banking.
C)Financial regulators discourage competition in banking.
D)Financial regulators prefer banks to have monopoly power in their geographic markets.

Question 73

Which of the following is not a positive effect of the Basel Accord?

A)It forced regulators to change the way they thought about bank capital.
B)It promoted a more uniform international system.
C)It provided a framework that less developed countries could use to improve the regulation of their banks.
D)It provided a system to differentiate between bonds based on their systemic risk.

Question 74

Bank mergers require government approval because banking officials want to make sure that:

A)the merger will create a larger bank.
B)the merger will not create a monopoly.
C)the merged bank will be more profitable.
D)the merger will not result in regulatory competition.

Question 75

You have savings accounts at two separately FDIC insured banks.At one of the banks your account has a balance of $200,000.At the other bank the account balance is $60,000.You find out the banks are going to merge.If you are concerned about the possibility of the new bank failing, you should:

A)do nothing; you are still insured up $250,000 per account.
B)consider moving $10,000 to another account at the same bank.
C)consider moving $10,000 to another account at a different bank.
D)do nothing; as an individual you are only insured up $250,000 no matter where the accounts are.

Question 76

One reason that financial regulations restrict the assets that banks can own is to:

A)combat the moral hazard that government safety nets provide.
B)limit the growth rate of banks.
C)prevent banks from being too profitable.
D)keep banks from spending lavishly on perks for executives.

Question 77

One reason a bank's officer may be reluctant to write off a past-due loan is that it will:

A)increase the bank's liabilities.
B)decrease the bank's assets and capital.
C)increase the bank's liabilities and assets, requiring more capital to be held.
D)make the bank's accounts less transparent.

Question 78

The supervision of banks includes:

A)requiring bank officers to attend classes on an annual basis.
B)on-site examinations of the bank.
C)extensive background checks of all bank officers.
D)requiring banks to file monthly reports on their revenues, expenses and profits.

Question 79

You have two savings accounts at an FDIC insured bank.You have $225,000 in one account and $40,000 in the other.If the bank fails, you will receive:

A)$225,000.
B)$40,000.
C)$115,000.
D)$250,000.

Question 80

Financial regulators set capital requirements for banks.One characteristic about these requirements is:

A)every bank will have to hold the same level.
B)the riskier the asset holdings of a bank, the more capital it will be required to have.
C)the more branches a bank has, the more capital it must have.
D)the amount of capital required is inversely related to the amount of assets the bank owns.