Chapter 12 – Depository Institutions: Banks and Bank Management
99. A bank has a need for cash for a short period of time to meet its liquidity needs. The bank
has significant holding of U.S. treasury securities. The bank really does not want to sell the
securities, realizing the liquidity need is a temporary problem. A pension fund has significant
cash holdings and would like to earn some return on part of these holdings. The problem is
the fund will need this cash in a few days to honor a purchase agreement it made for
municipal bonds being issued. Is there any way these two organizations can work together to
solve each other’s problem?
100. Explain why a bank manager and a bank regulator would likely view the timing at which
a loan should be charged to the loan loss reserve differently.
Chapter 12 – Depository Institutions: Banks and Bank Management
101. You are provided with the following information: a bank has a net income after taxes of
$3.5 million; it has assets of $150 million; and bank capital of $12.5 million. What is the
bank’s return on assets; its return on equity, and its debt-to-equity ratio?
102. Explain why a bank with a high debt-to-equity ratio may be more profitable than a bank
with a lower ratio but would also have a higher level of risk.
Chapter 12 – Depository Institutions: Banks and Bank Management
103. Considering that, on average, the return on assets is the same for small and large banks,
and the return on equity is higher for large banks than small banks, what can be one of the
explanations for the trend toward bank mergers?
104. We saw in Chapter 12 that initially savings and loans were created to make home
mortgages, and their main source of funds was deposits from savers. In the late 1970s and into
the 1980s, the U.S. experienced rising interest rates that had depositors looking for higher
returns. Congress quickly removed the interest rate ceilings that savings and loans could offer.
Explain the initial impact this had on the interest rate spread and the net interest margin for
the savings and loans.
Chapter 12 – Depository Institutions: Banks and Bank Management
105. As the end of the year 1999 approached, many people worried that banks and more
specifically the banks’ computers would not be able to read the year 2000 correctly. This was
commonly known as the Y2K problem. Many people were concerned that their bank would
lose the record of their deposits etc., and made plans to take most of their funds out of the
bank. Address the potential Y2K problem from the standpoint of bank risk. What two types of
risk potentially could have been involved?
106. If the Federal Reserve were to do away with the required reserve regulation, do you think
banks would stop holding reserves? Explain.
Chapter 12 – Depository Institutions: Banks and Bank Management
107. A bank has the following assets: Reserves of $15 million; Loans of $150 million; and
Securities of $50 million. Their liabilities include Deposits of $150 million; Borrowed funds
of $35 million and Bank Capital of $30 million. If the required reserve rate is 10 percent,
answer the following: What is the amount of excess reserves the bank is currently holding?
What are the options available to the bank if customers decide to withdraw $10 million in
deposits?
108. Information asymmetry that exists in lending creates what type of risk for banks?
Discuss the ways for a bank to handle or minimize this risk.
Chapter 12 – Depository Institutions: Banks and Bank Management
109. If you focus on interest-rate risk, can you explain why banks offer higher interest rates
on longer-term CDs than they do on short-term CDs?
110. A bank has $100 million in assets and 50 percent of its assets are interest sensitive. The
bank has $75 million in liabilities, 50 percent of which are interest sensitive. What is the
bank’s gap between interest-sensitive assets and liabilities?
Chapter 12 – Depository Institutions: Banks and Bank Management
111. A home buyer is presented with two options for financing the purchase of a home: a 20
year fixed rate mortgage or a 20 year adjustable-rate mortgage. Which mortgage would you
expect to start at the lowest interest rate and why?
112. The trading losses that some banks incurred could be thought to be from trading risk, but
in many cases the real cause of the losses could be attributed to moral hazard. Why was this
the case?
Chapter 12 – Depository Institutions: Banks and Bank Management
113. Why do you think banks in the U.S. are prohibited from owning securities (stocks and
bonds) of corporations?
114. What should be the impact on a bank’s return on assets and return on equity from
increased use of off-balance-sheet activities?
Chapter 12 – Depository Institutions: Banks and Bank Management
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115. A bank develops specialized skills in analyzing companies from one specific industry.
This contributes significantly to the bank achieving economies of scale because a large
portion of its total loan portfolio is made up of companies in this industry. What are the long-
run profit prospects for this bank? Explain.
116. The practice of “redlining” in bank lending is clearly an example of discrimination in
lending. Agree or disagree? Why?
The term “redlining” alludes to a practice in which bank officers would not lend in certain
areas marked off by redlines drawn on a map. From a lender’s perspective, such a practice is a
way to manage credit risk. If default rates are higher in one area than another, banks will have
Essay Questions
Chapter 12 – Depository Institutions: Banks and Bank Management
117. Japanese banks from the 1990’s to the present have lost considerable amounts of capital.
If you were hired to clean up the Japanese banking sector, what reforms would you
prescribe?
Chapter 12 – Depository Institutions: Banks and Bank Management
118. An argument that comes up from time to time is that credit unions have an advantage
over other financial depository institutions in the sense that they are non-profit institutions
and, therefore, are exempt from taxes on income that other private depository institutions pay.
As a result, credit unions may be able to charge lower rates of interest to borrowers and pay a
higher rate to depositors than these other institutions. What do you think of this argument?
119. In Chapter 11 we discussed the principal-agent problem as a form of moral hazard.
Discuss the unique problems a bank manager faces in terms of trying to please the owners of
the bank and at the same time trying to appease regulators.
Chapter 12 – Depository Institutions: Banks and Bank Management
120. Bank managers seem to have to walk a tightrope between managing risk and earning a
profit. Explain.
121. The primary difference among various kinds of depository institutions is in the
composition of their loan portfolios Agree or disagree? Explain.