monaey and banking exam 2
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as financial intermediaries, what are banks function?
they transfer funds from savers to borrowers
banking over time has had what kind of reputation?
conservative and staid
what has changed in banking and why?
economic conditions, changes in financial regulations, improvements in computing and telecommunications because banks must change how they handle information.
how do banks operate?
accepts deposits from savers and makes loans to borrowers. They provide liquidity for people and for business
what is adverse selection?
the problem that people or firms that are worse than average risks are more likely to seek out loans than borrowers that are better than average risks.
what is asymmetric information?
a situation in which one party in a transaction knows more than another(used car sales lemon)
what is moral hazard?
the situation in which the existence of a contract changes the behavior of a party to the contract; for example, if a firm acts differently after they receive a loan that may harm the bank.
how can banks protect themselves from asymmetric information?
collateral- an asste of value that a borrower peomises to give the bankif that borrower is unable to repay the banks loan.
covenant- legally enforced part of a loan contract that requires the borrower to act in a certain way or to use the borrowed funds for a particular purpose.
what happenned during the savings and loan crisis?
- risky activities of s&l's
- lendiong money to borrowers in their local areas only and for home mortgages only, causing their portfolios to become undiversified both geographically and in the types of assets they owned.
s&l's attracted short term depositsbut made long term loans
what happenned during the credit crunch of the early 1990s?
a credit crunch is where banks do lend money as they ordinarly would but rather have much higher requirements for borrowers to qualify for loans than normal.
it happended because of lax lending standards
what happenned during the financial crisis of 2008
in 07 house prices began to fall causing people to pay more for their houses than they were actually worth. ppl were unable to pay, banks lost the money, investors feared they would lose money so they pulled out their investments, stocks fell, and recession occurred.
what are a banks liabilities?
- transaction deposits
- nontransaction deposits
- equity capital
what is reserve accounting?
banks manage their funds by adjusting the size of their reserves. reserves are also a key variable for monetary policy because the feds actions affect banks reserves
what is excess reserves?
having over and above what u need, if u have too much, you can invest the surplus
fed funds market?
the market in which banks with excess reserves lend them to banks that desire additional reserves
how do banks earn profits?
interest from borrowers who take out loans and from the securities the bank owns, also ATM fees, safe depsit boxes, managing investments, retirement accnts, phone banking internet banking
what is a spread?
the difference b/w the average interest rate on a banks assets and the average interest rate on its liabilities.
what are the risks banks take?
default risk aka credit risk is the possibility that a banks loan customers might not repay their loans as specified in the loan agreementor that the issuer of securities the bank owns will not pay interest
interest rate risk is when mrkt interest rates change thus affecting the value of a banks assets both loans and securities
how do banks control risk?
- redundant accounting
- frequent auditing
- diversified portfolio
why are interest rates on credit cards so high?
- adverse selection
- demand for cards is fairly inelastic
- mix of ppl who use cards has changed over time from dignified to college students
what makes up the reserve in a bank?
in what ways are banks special?
they are essential to the operation of the payments system and the circulation of money, also they are vested with the public interest.
how do banks unique nature relate to the level of supervision of banks?
because of their unique nature, they are watched more than any other industry.
why does the government regualte banks?
- reduce externalities caused by bank problems
- keep banks small
- prevent bank runs
- ensure that payments flow through the banking system efficiently
- stabilize money supply
glass steagall act?
1933 estabilshes FDIC prohibits commercial banks from investing and owning commercial firms and vice versa and interest payments on demand deposits
what is depository institutions deregulation and monetary control act?
1980-allows payment of interest on transactions accounts of individuals, phases out interest rate ceilings on deposits, makes all depository institutions subject to reserve requirements gives thrifts the ability to own a wider range of assets raises deposit insurance to $100,000
what is the FDIC improvement act?
1991- creates risk based deposit insurance premiums; requires FDIC to use least cost methods for bank failures causing many banks to increase capital
what is too big to fail?
a poilicy in which bank regulators will not close a bank that is deemed to be so large that its closure would affect the financial system and cause other banks to fail instead the government will mkae loans to the bank to keep it afloat
what issue faced many major banks during the financial crisis of 2008?
many banks had a shortage of liquidity
how are banks supervised?
dual banking system- system where a bank chooses whether to be chartered by federal government or by state governemnt
c- in camels
a in camels
s in camels
sensitivity to risk
how are mergers evaluated?
- herfindahl hirschman index(HHI)
- the effect on competition
- the adequacy of financial and managerial resources of the new bank
- the ability of the bank to meet the convienence and needs of the community,
- whether the banks provided complete information about merger or acquisitionto banking authorities
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