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Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 127
Chapter 10
ANSWERS TO QUESTIONS
1. Why are deposit insurance and other types of government safety nets important to the health
of the economy?
2. If casualty insurance companies provided fire insurance without any restrictions, what kind
of adverse selection and moral hazard problems might result?
3. Do you think that eliminating or limiting the amount of deposit insurance would be a good
idea? Explain your answer.
4. How could higher deposit insurance premiums for banks with riskier assets benefit the
economy?
5. What are the costs and benefits of a too-big-to-fail policy?
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 130
14. Suppose Universal Bank holds $100 million in assets, which are composed of the following:
Required reserves: $10 million
Excess
reserves: $ 5 million
Mortgage
loans: $20 million
Corporate bonds: $15 million
Stocks: $25 million
Commodities: $25 million
a. Do you think it is a good idea for Universal Bank to hold stocks, corporate bonds, and
commodities as assets? Why or why not?
b. If the housing market suddenly crashed, would Universal Bank be better off using a
mark-to-market accounting system or the historical-cost system?
c. If the price of commodities suddenly increased sharply, would Universal Bank be better
off using a mark-to-market accounting system or the historical-cost system?
d. What do your answers to parts (b) and (c) tell you about the tradeoffs between the two
accounting systems?
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 131
15. Why might more competition in financial markets be a bad idea? Would restrictions on
competition be a better idea? Why or why not?
16. In what way might consumer protection regulations negatively affect a financial
intermediary’s profits? Can you think of a positive effect of such regulations on profits?
Consumer protection regulations in general make sure that all relevant information is
disclosed to potential borrowers (including costs and conditions of loans) and forbid
ANSWERS TO APPLIED PROBLEMS
17. Consider a failing bank. A deposit of $350,000 is worth how much to the depositor if the
FDIC uses the payoff method given the typical recovery rate? How much is the same deposit
worth to the depositor if the purchase-and-assumption method is used? Which is more costly
to taxpayers?
Under the payoff method, the depositor only gets around $0.90/dollar on the amount of the
18. Consider a bank with the following balance sheet:
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 132
Copyright © 2019 by Pearson Education, Inc. All rights reserved.
Reserves and T-bills have a zero weight. So, $20 million has zero weight. Municipal bonds
and Residential Mortgages carry a 50% weight. Risk-weighted assets = $135 million × 0.50
= $67.5 million. Commercial loans carry a 100% weight. Risk-weighted assets = $60 million.
Total risk-weighted assets = $67.5 + $60 = $127.5 million.
Calculate the bank’s risk-weighted assets.Problems 19–21 relate to a sequence of transactions
at Oldhat Financial.
19. Oldhat Financial starts its first day of operations with $9 million in capital. A total of $130
million in checkable deposits is received. The bank makes a $25 million commercial loan and
another $50 million in mortgages with the following terms: 200 standard, 30-year, fixed-rate
mortgages with a nominal annual rate of 5.25%, each for $250,000.
Assume that required reserves are 8%.
a. What does the bank balance sheet look like?
b. How well capitalized is the bank?
c. Calculate the risk-weighted assets and risk-weighted capital ratio after Oldhat’s first day.
a.
Assets
Liabilities
Required Reserves
$10.4 million
Checkable Deposits
$130 million
Excess Reserves
Loans
$53.6 million
$75 million
Bank Capital
$9 million
c. Reserves have a zero weight. So, $64 million has zero weight. Residential mortgages
20. Early the next day, the bank invests $50 million of its excess reserves in commercial loans.
Later that day, terrible news hits the mortgage markets, and mortgage rates jump to 13%,
implying a present value of Oldhat’s current mortgage holdings of $124,798 per mortgage.
Bank regulators force Oldhat to sell its mortgages to recognize the fair market value. What
does Oldhat’s balance sheet look like? How do these events affect its capital position?
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 133
Copyright © 2019 by Pearson Education, Inc. All rights reserved.
The sale of each mortgage would be recorded as:
Debit
Credit
Cash
$124,798
Mortgages
$250,000
Loss
$125,202
After the fact, the actual balance sheet is:
Assets
Liabilities
Required Reserves
$10.4 million
Checkable Deposits
$130 million
Excess Reserves
Loans
$28.6 million
$75 million
Bank Capital
−$16 million
21. To avoid insolvency, regulators decide to provide the bank with $25 million in bank capital.
However, the bad news about the mortgages is featured in the local newspaper, causing a
bank run. As a result, $30 million in deposits is withdrawn. Show the effects of the capital
injection and the bank run on the balance sheet. Was the capital injection enough to stabilize
the bank? If the bank regulators decide that the bank needs a capital ratio of 10% to prevent
further runs on the bank, how much of an additional capital injection is required to reach a
10% capital ratio?
22.
Assets
Liabilities
Required Reserves
$ 8 million
Checkable Deposits
$100 million
Excess Reserves
Loans
$26 million
$75 million
Bank Capital
$ 9 million
The bank now has a 9/109 = 8.3% capital ratio; it is again well capitalized. With the run on the
bank, checkable deposits fall to $100 million. In order to have a bank capital ratio of 10%, it
must be the case that 0.10 = BC/(100 + BC ), where BC represents the required level of bank
capital. Solving for BC yields a level of bank capital needed of $11.1 million. Thus, the regulators
would need to inject an additional $2.1 million to reach a 10% capital ratio.
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 134
ANSWERS TO DATA ANALYSIS PROBLEMS
1. Go to the St. Louis Federal Reserve FRED database and find data on the number of
commercial banks in the United States in each of the following categories: average assets
less than $100 million (US100NUM), average assets between $100 million and $300 million
(US13NUM), average assets between $300 million and $1 billion (US31NUM), average
assets between $1 billion and $15 billion (US115NUM), and average assets greater than $15
billion (USG15NUM). Download the data into a spreadsheet. Calculate the percentage of
banks in the smallest (less than $100 million) and largest (greater than $15 billion)
categories, as a percentage of the total number of banks, for the most recent quarter of data
available and for 1990:Q1. What has happened to the proportion of very large banks? What
has happened to the proportion of very small banks? What does this say about the “too-big-
to-fail” problem and moral hazard?
In 1990:Q1, there were 25 ‘very large’ banks, and 9,529 ‘very small’ banks, representing
0.2% and 76.5% of total commercial banks in the United States, respectively. For the most
2. Go to the St. Louis Federal Reserve FRED database and find data on the residual of assets
less liabilities, or bank capital (RALACBM027SBOG), and total assets of commercial banks
(TLAACBM027SBOG). Download the data from January 1990 through the most recent
month available into a spreadsheet. For each monthly observation, calculate the bank
leverage ratio as the ratio of bank capital to total assets. Create a line graph of the leverage
ratio over time. All else being equal, what can you conclude about leverage and moral
hazard in commercial banks over time?
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 135
Copyright © 2019 by Pearson Education, Inc. All rights reserved.
See graph below. In January 1990, the leverage ratio was 6.6%, and the most recent month of
May 2017, the leverage ratio was 10.9%. The graph clearly illustrates a gradual increase in
the leverage ratio over time for commercial banks, indicating that, holding everything else
constant, moral hazard in the banking system should have gradually declined over that
period.
