Chapter 14 – Regulating the Financial System
100. In 1873, British economist Walter Bagehot proposed the central bank function as the
lender of last resort. Specifically, he suggested the central bank lend freely to banks which
have good collateral at high rates of interest. Why the requirements of good collateral and a
high rate of interest?
101. Does the lender of last resort function guarantee an end to bank runs? Explain.
102. How does the lender of last resort potentially create a moral hazard problem?
Chapter 14 – Regulating the Financial System
103. You have a retirement account in a bank that has failed. The balance in your account is
$330,000. Does it make a difference to you if FDIC uses the payoff method or the purchase-
and-assumption method for resolving this insolvency? Explain.
104. Imagine a situation where the deposits at state chartered banks would be insured by a
state insurance fund and deposits at nationally chartered banks would be insured by FDIC.
How would you expect both depositors and banks would react?
Chapter 14 – Regulating the Financial System
105. Explain why the ratio of assets to capital increased dramatically for commercial banks
from the 1920s to the present.
106. You are the head of finance for a very large corporation located in a relatively small
town. At a local chamber of commerce meeting, the president of the local bank asks you why
you keep the corporation’s bank accounts in a very large mid-western bank and not in his local
bank. From a risk reduction perspective, how could you answer his question?
Chapter 14 – Regulating the Financial System
107. What is the link between the safety net provided by the government to the financial
industry and the relatively heavy regulation of the same industry by the government?
108. What three strategies are employed by government officials to ensure that the risks
created by the government safety net are contained?
109. What potential problems are created by regulatory competition?
Chapter 14 – Regulating the Financial System
110. Besides regulating banks, the government also regulates nondepository financial
institutions, such as insurance companies. Consider a property casualty insurance company;
why would the government need to regulate them?
111. You get married and, in doing some basic financial planning, your spouse suggests that
the two of you open separate accounts so that if your total deposits exceed $250,000, your
funds will be protected by FDIC. How would you respond to the suggestion?
Chapter 14 – Regulating the Financial System
112. Explain how bank regulators seem to face a bit of a paradox regarding preventing
monopoly power by banks and spurring competition.
113. Why are banks restricted in the assets that they can own? For example, why do you think
banks are prohibited from owning common stock?
Chapter 14 – Regulating the Financial System
114. If we lived in an economy where interest rates were highly volatile, would you expect
the maximum asset to capital ratio that a regulator would allow to increase or decrease and
why?
115. What was the primary motivation behind the creation of the 1988 Basel Accord?
Chapter 14 – Regulating the Financial System
116. What were the positive effects of the 1988 Basel Accord? What were its shortcomings?
117. What are the three pillars of the 1998 Basel Accord?
Chapter 14 – Regulating the Financial System
118. Identify at least two problems a borrower would face if banks were not required to
disclose the information that they are currently required to make available.
119. Define the components of the CAMELS criteria and explain how a CAMELS rating is
calculated.
Chapter 14 – Regulating the Financial System
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120. The CAMELS criteria to evaluate the health of banks by supervisors is not made public.
Make a case for one making this information public and a case for keeping it private.
121. How have regulators in the US responded to the financial crisis of 2007-2009?
Essay Questions
Chapter 14 – Regulating the Financial System
122. Discuss the ramifications of the FDIC reducing deposit insurance limits to $25,000.
123. We saw in the text that regulations, specifically deposit insurance and the Basel Accord
(of 1988), can create moral hazard. Explain.
Chapter 14 – Regulating the Financial System
124. The FDIC used to charge all banks the same rate for insurance on deposits. From what
you have learned, what problems did this create for not only the FDIC but for well run
banks?
Chapter 14 – Regulating the Financial System
125. Discuss the case for a “super-regulator” in the context of what you have learned about
“regulatory competition.”