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Chapter 10: Q 1. (page 284)

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 鈥渢oo-big-to-fail鈥� problem and moral hazard?

Short Answer

Expert verified

Proportion of large banks has increased and that of small banks has decreased. The too big to fail problem and moral haard asosciated with it continue to exist.

Step by step solution

01

Step 1. Introduction

The "too big to fail" problem refers to those financial institutions in the economy which can lead to disastrous effects if they failed. If such institutions face a financial crisis or insolvency situation. The government is likely to bail them out because not doing so would be extremely harmful for the economy.

02

Step 2. Explanation

The data obtained from the Federal reserve database can be represented in a tabular form as:

YearUS100NUMUS13NUMUS31NUMUS115NUMUSG15NUMTotal No. of banks
1990:Q19,5291,9875813422512,464
2020:Q39211,5341,210611994,562

The percentage of banks in the smallest and largets categories can be shown as:

YearUS100NUMUSG15NUM
1990:Q1(9,529/12,464)*100 = 76.45(25/12,464)*100 = 0.2%
2020:Q3(921/4,562)*100 = 20.18(99/4,562)*100 = 2.17%

From the above data, it is evident the total number of banks has decreased over the years. The percentage of smallest banks has decreased from 76.45% in 1990 to 20.18% in 2020. On the other hand, the percentage of the largest banks has increased from 0.2% in 1990 to 2.17% in 2020.

The data shows the increase in a large number of banks has continued the problem of too big to fail commercial banks. Such banks are aware that the government would rescue them in case of failure. This leads to moral hazard as these banks knowingly get involved in risky lending.

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Most popular questions from this chapter

To avoid insolvency, regulators decide to provide the bank with \(27 million in bank capital. Assume that bad news about mortgages is featured in the local newspaper, causing a bank run. As a result, \)40 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?

Consider a bank with the following balance sheet:

AssetsLiabilities
Required reserves \(9millionCheckable deposits \)90million
Excess reserves \(2millionBank capital \)6million
T-bills \(46million
Commercial loans\)39million

The bank makes a loan commitment for $15million to a commercial customer. Calculate the bank鈥檚 capital ratio before and after the agreement. Calculate the bank鈥檚 risk-weighted assets before and after the agreement. Problems 19鈥�21 relate to a sequence of transactions at Oldhat Financial.

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?

Why has the trend in bank supervision moved away from a focus on capital requirements to a focus on risk management?

What are some of the limitations to the Basel and Basel 2 Accords? How does the Basel 3 Accord attempt to address these limitations?
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