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Chapter 10: Q.4 (page 283)

How could higher deposit insurance premiums for banks with riskier assets benefit the economy?

Short Answer

Expert verified

The higher deposit insurance premium for banks with riskier assets would be beneficial to the economy. The amount of deposit insurance premium determines the level of risk. The riskier assets result from issuing of loans.

Step by step solution

01

Concept Introduction

Economy would be benefitted by increase in deposit insurance premium for banks with riskier assets. The deposit insurance premium determines the level of risk in the economy. The riskier assets result from issuing of loans.

02

Explanation

Moral hazard and adverse selection issues can be addressed by increasing premiums on deposit insurance.

The riskier assets result from issuing of loans. The increasing deposit insurance premiums put control on the degree of risk that banks take. In this sense, higher deposit insurance premiums for banks can help reduce riskier assets, thereby benefiting the economy.

03

Final Answer

There is a benefit to the economy if banks with riskier assets pay higher deposit insurance premiums. The cost of deposit insurance premiums can be increased to reduce moral hazards and adverse selection.

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Most popular questions from this chapter

Oldhat Financial starts its first day of operations with \(11million in the capital. A total of \)120million in checkable deposits are received. The bank makes a \(30million commercial loan and another \)40million in mortgages with the following terms: 200standard, 30-year, fixed-rate mortgages with a nominal annual rate of 5.25%, each for $200,000. 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鈥檚 first day.

Why might more competition in financial markets be a bad idea? Would restrictions on competition be a better idea? Why or why not?

What are the costs and benefits of a too-big-to-fail policy?

Early the next day, the bank invests \(35million of its excess reserves in commercial loans. Later that day, terrible news hits the mortgage markets, and mortgage rates jump to 13%, implying a present value of Oldhat鈥檚 current mortgage holdings of \)99838 per mortgage. Bank regulators force Oldhat to sell its mortgages to recognize the fair market value. What does Oldhat鈥檚 balance sheet look like? How do these events affect its capital position?

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?

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