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Chapter 9: Q. 15 (page 264)

鈥淏ecause diversification is a desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans.鈥� Is this statement true, false, or uncertain? Explain your answer

Short Answer

Expert verified

The given statement is misleading because when a bank specializes in making particular sorts of loans, it can show economies of scale and perform all the more proficiently. Specialization permits the bank to collect data regarding regional firms and find their creditworthiness more comfortable. This decreases the negative choice situation in which banks do not understand which firms have more adequate credit than the rest and decreases the chance of default.

Step by step solution

01

Concept Introduction

Diversification is the stratgey adopted to lower the risk in investment. Under this strategy, all the capital is not invested on one thing rather it is spread over a variety of high-risk and low-risk assets.

02

Explanation

The given statement is misleading because when a bank specializes in making particular sorts of loans, it can show economies of scale and perform all the more proficiently. Specialization permits the bank to collect data regarding regional firms and find their creditworthiness more comfortable. This decreases the negative choice situation in which banks do not understand which firms have more adequate credit than the rest and decreases the chance of default. In addition, when the bank expands loans, it collects interest periodically and these charges are backed by agreements and collaterals. Therefore, reimbursement on its loans is not that unsafe.

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Most popular questions from this chapter

If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down, explaining that you don鈥檛 have any excess reserves to lend out? Why or why not? What options are available that will enable you to provide the funds your customer needs?

Using the T-accounts of the First National Bank and the Second National Bank given in this chapter, describe what happens when Jane Brown writes a check for $90on her account at the First National Bank to pay her friend Joe Green, who in turn deposits the check in his account at the Second National Bank.

It is relatively easy to find up-to-date information on banks because of their extensive reporting requirements. Go to http://www2.fdic.gov/qbp/, where you will find summary data on financial institutions. This site is sponsored by the Federal Deposit Insurance Corporation. Click on 鈥淨uarterly Banking Profile,鈥� select the most recent quarter and access QBP, click on 鈥淐omplete QBP鈥� and scroll to Table I-A.

a. Have banks鈥� returns on assets been increasing or decreasing over the past few years?

b. Has the core capital been increasing, and how does it compare to the capital ratio reported in Table 1 of the text?

c. How many institutions are currently reporting to the FDIC?

If the president of a bank told you that the bank was so well run that it has never had to call in loans, sell securities, or borrow as a result of a deposit outflow, would you be willing to buy stock in that bank? Why or why not?

What happens to reserves at the First National Bank if one person withdraws \(1,100of cash and another person deposits\)200of cash? Use T-accounts to explain your answer.
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