Question 1

As a result of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), the deposit insurance fund for the savings and loan industry has been combined with the deposit insurance fund for the commercial banking industry.

Accepted Answer

False

Question 2

Deposit insurance is often blamed for the deterioration in depositor discipline that allowed FIs to accept more risk in the asset selection process.

Accepted Answer

Deposit insurance can create a moral hazard where depositors feel protected from losses and therefore do not exercise the same level of caution in selecting FIs, allowing FIs to take on more risk in their investment decisions.

Question 3

Since its inception, the FDIC deposit insurance fund has never fallen to a negative balance.

Accepted Answer

The FDIC deposit insurance fund has fallen to a negative balance before, notably during the financial crisis that began in 2008, due to a high number of bank failures.

Question 4

During the financial crisis of 2008-2009, deposit balances at DIs increased.

Accepted Answer

During times of financial uncertainty, individuals and businesses often choose to hold their money in bank accounts as a safe haven for their funds. This can lead to an increase in deposit balances at DIs during a crisis.

Question 5

Moral hazard encourages the FI to take on more, rather than less, risk.

Accepted Answer

Moral hazard occurs when a party insulated from risk behaves differently than it would if it were fully exposed to the risk. In the case of financial institutions (FIs), moral hazard can occur when FIs know that they may be bailed out by the government or have access to other forms of financial support. This can encourage them to take on more risk than they would if they were fully exposed to the consequences of their actions. Therefore, moral hazard can lead to FIs taking on more risk.

Question 6

The number of bank failures in the period of 1933-79 was less than the number of failures from 1980-1989.

Accepted Answer

The answer of The number of bank failures in the...

Question 7

After nearly failing, the FDIC's Bank Insurance Fund (BIF) achieved record levels of reserves during the 1990s.

Accepted Answer

The FDIC's Bank Insurance Fund (BIF) did indeed achieve record levels of reserves during the 1990s, after experiencing significant challenges and nearly failing in the late 1980s and early 1990s.

Question 8

Contagious runs on bank deposits are directed at FIs, whether they are failing or healthy.

Accepted Answer

Contagious runs on bank deposits can occur both in failing and healthy financial institutions, as they can be triggered by systemic risks and financial panic that spreads throughout the market.

Question 9

If regulators provide more protection against bank runs, the incidence of moral hazard is likely to increase.

Accepted Answer

When regulators provide more protection against bank runs, depositors and investors may feel more secure and be more willing to engage in risky behavior, assuming that the government will always bail out failing banks. This leads to moral hazard, as banks take on more risk knowing that they are backed by government guarantees.

Question 10

A major reason for the deterioration of the deposit insurance funds in the 1980s was the downturn in the technology, manufacturing, and real estate industries.

Accepted Answer

The answer of A major reason for the deterioration of...

Question 11

The average cost to the FDIC of each bank failure during the decade of the 1980s was larger than the total cost of all bank failures during the period 1933-79.

Accepted Answer

According to FDIC data, the average cost of each bank failure during the 1980s was $772 million, while the total cost of all bank failures during the period 1933-79 was $8.6 billion. Therefore, the average cost of each bank failure in the 1980s was larger than the total cost of all bank failures during 1933-79.

Question 12

Pricing insurance premiums in an actuarially fair manner involves assessing the risk-taking profile of the financial institution.

Accepted Answer

This statement is true. Actuarial fairness involves calculating premiums based on risk, including factors such as age, health, driving history, and more. This helps ensure that higher-risk individuals or groups pay higher premiums, while lower-risk individuals or groups pay lower premiums.

Question 13

The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) restructured the savings association deposit insurance fund and transferred its management to the FDIC.

Accepted Answer

This is a factual statement about the provisions of the FIRREA, which was passed in 1989. The act also established the Resolution Trust Corporation to handle the savings and loan crisis that had been ongoing since the 1980s.

Question 14

Moral hazard provides an incentive for bank owners to accept greater asset risks because they have less to lose, and potentially more to gain.

Accepted Answer

Moral hazard occurs when someone is shielded from the negative consequences of their actions, leading them to take greater risks. In the case of bank owners, if they know that the government will bail them out if their assets fail, they may be more willing to take on riskier assets in the hope of higher returns, knowing that they won't bear the full consequences of any losses. As a result, moral hazard can incentivize banks to accept greater asset risks.

Question 15

The Federal safety net to protect the integrity of the payments system consists of deposit insurance and social welfare.

Accepted Answer

The Federal safety net primarily consists of deposit insurance and access to central bank credit to protect the integrity of the payments system, not social welfare.

Question 16

A major cause of the FSLIC insolvency in the 1980s was the dramatic rise in interest rates in 1979-82 that created extensive duration mismatches of assets and liabilities in the savings and loan industry.

Accepted Answer

The rise in interest rates in 1979-82 did cause duration mismatches in the savings and loan industry, which ultimately led to the insolvency of the FSLIC.

Question 17

Explicit deposit insurance premiums applied by regulators can involve restricting and more closely monitoring the risky activities of banks.

Accepted Answer

The answer of Explicit deposit insurance premiums applied by regulators...

Question 18

The adverse effects of a contagious run include the restrictions on the ability of individuals to transfer wealth through time and a negative impact on the level or rate of savings.

Accepted Answer

A contagious run can lead to panic selling, which can cause a steep decline in asset prices. This can restrict the ability of individuals to transfer wealth through time, as their assets lose value quickly. Additionally, a contagious run can create uncertainty and fear, which can discourage people from saving and investing, leading to a negative impact on the level or rate of savings.

Question 19

The risk of moral hazard increases when capital levels are low.

Accepted Answer

When capital levels are low, a financial institution may feel more inclined to take on risky investment strategies in order to generate higher returns and replenish its capital. However, this creates a potential for moral hazard, as the institution may be motivated to take excessive risks knowing that they can "socialize" the losses if things go wrong (i.e., rely on government bailouts or other forms of support). In other words, low capital levels increase the incentives for a financial institution to engage in risky behavior, which in turn increases the likelihood of moral hazard.

Question 20

A run on a bank is not necessarily a bad occurrence.

Accepted Answer

A run on a bank can be a signal of confidence in the bank, and if the bank has sufficient reserves, it can handle the withdrawals without facing any major problems. However, if the bank does not have enough liquidity, a run on the bank can lead to a crisis in the banking system.

Quiz 19: Deposit Insurance and Other Liability Guarantees