Question 1

19-14 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 reduces the level of risk perceived by depositors and may lead to moral hazards, as they may not prioritize evaluating the financial stability of the institution. As a result, FIs can take on more risk when choosing assets because they perceive it to be less risky than it actually is.

Question 2

19-7 During the financial crisis of 2008-2009,deposit balances at DIs increased.

Accepted Answer

During times of economic uncertainty, people tend to move their money into more secure locations such as banks, resulting in an increase in deposit balances at depository institutions (DIs). This phenomenon was observed during the financial crisis of 2008-2009.

Question 3

19-9 After nearly failing,the FDIC's Bank Insurance Fund (BIF)achieved record levels of reserves during the 1990s.

Accepted Answer

The statement is true.

Question 4

19-15 Moral hazard encourages the FI to take on more,rather than less,risk.

Accepted Answer

Moral hazard can lead to FI taking on more risk as they know they are protected from losses to some extent. This may incentivize them to engage in riskier behavior which can lead to negative consequences for themselves and the broader financial system.

Question 5

19-16 The risk of moral hazard increases when capital levels are low.

Accepted Answer

When capital levels are low, banks may be more likely to take excessive risks or engage in behavior that could lead to a financial crisis because they have limited resources to absorb losses. This can lead to moral hazard, where banks may feel that the government or other institutions will bail them out if they encounter financial difficulties. Thus, the risk of moral hazard increases when capital levels are low.

Question 6

19-20 Pricing insurance premiums in an actuarially fair manner involves assessing the risk-taking profile of the financial institution.

Accepted Answer

Actuarial fairness in setting insurance premiums involves evaluating the risk profile of the financial institution to ensure that premiums are based on the actual risk of loss or damage covered by the insurance policy. Therefore, the statement is true.

Question 7

19-4 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 to protect the integrity of the payments system primarily consists of deposit insurance and the lender of last resort function, not social welfare.

Question 8

19-18 Explicit deposit insurance premiums applied by regulators can involve restricting and more closely monitoring the risky activities of banks.

Accepted Answer

The answer of 19-18 Explicit deposit insurance premiums applied by...

Question 9

19-13 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 19-13 A major reason for the deterioration...

Question 10

19-17 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 are less likely to withdraw their funds early, which reduces the likelihood of a bank run. However, this may also make banks less cautious in their lending and investment practices as they know that the likelihood of a bank run is low. This creates a moral hazard problem where banks can take on more risk without fear of consequences, which increases the likelihood of financial instability. Therefore, more protection against bank runs can increase the incidence of moral hazard.

Question 11

19-8 Since its inception,the FDIC deposit insurance fund has never fallen to a negative balance.

Accepted Answer

The FDIC deposit insurance fund did fall to a negative balance during the financial crisis in 2009.

Question 12

19-19 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 refers to the situation where a party takes risks because they will not bear the full consequences of their actions. In the case of bank owners, if they know that they will be protected by deposit insurance, they may be more willing to take on greater asset risks than they would be if they knew they would bear the full consequences of their actions. This is because the potential gains from taking on greater risks may be higher than the potential losses.

Question 13

19-6 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

The FDIC's average cost per bank failure during the 1980s was around $400 million, while the total cost of all bank failures from 1933-1979 was approximately $40 billion. Therefore, the average cost per bank failure in the 1980s was indeed larger than the total cost of all bank failures from 1933-1979.

Question 14

19-5 The number of bank failures in the period of 1933-79 was less than the number of failures from 1980-1989.

Accepted Answer

The period from 1933 to 1979 saw fewer bank failures due to the stability brought by the New Deal reforms, while the 1980s experienced a significant increase in bank failures due to deregulation and economic challenges.

Question 15

19-11 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

FIRREA created separate deposit insurance funds for savings and loan associations and commercial banks.

Question 16

19-10 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

The Financial Institutions Reform, Recovery, and Enforcement Act did indeed restructure the savings association deposit insurance fund and move it under the management of the FDIC.

Question 17

19-2 A run on a bank is not necessarily a bad occurrence.

Accepted Answer

A run on a bank can be a sign of increased liquidity demands, which can be a positive indicator for the economy. However, if the bank is not able to meet the demand for withdrawals, it can lead to a financial crisis.

Question 18

19-1 Contagious runs on bank deposits are directed at FIs,whether they are failing or healthy.

Accepted Answer

Contagious runs on bank deposits can affect both failing and healthy financial institutions. They occur when depositors lose confidence in the banking industry as a whole and start withdrawing their funds, regardless of the individual bank's financial health. This can lead to a domino effect, as the withdrawal of deposits from one institution can cause other depositors to panic and withdraw their funds, ultimately leading to a systemic banking crisis.

Question 19

19-12 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 statement is true. The rapid rise in interest rates during that period caused many S&Ls to experience a significant mismatch between the maturities of their assets and liabilities, leading to insolvency for the Federal Savings and Loan Insurance Corporation (FSLIC) and other savings and loan institutions.

Question 20

19-3 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 create a sense of urgency to withdraw funds, which can limit individuals' ability to transfer wealth through time. Additionally, if individuals are forced to liquidate assets in order to meet immediate financial needs, this can lead to a decrease in savings.

Quiz 19: Deposit Insurance and Other Liability Guarantees