Deck 19: Deposit Insurance and Other Liability Guarantees

Question 1

Pricing deposit insurance premiums to reflect increases in risk-taking by financial institutions is one method to reduce incentives to take risks.

Answer 1

True

Question 2

Moral hazard provides an incentive for bank owners to accept greater asset risks because they have less to lose, and potentially more to gain.

Answer 2

True

Question 3

The risk of moral hazard increases when capital levels are low.

Answer 3

True

Question 4

Deposit insurance is often blamed for the deterioration in depositor discipline that allowed FIs to accept more risk in the asset selection process.

Question 5

Statistical credit scoring models have been suggested for use in measuring the risk of DIs for the purpose of assigning deposit insurance premiums.

Question 6

Moral hazard encourages the FI to take on more, rather than less, risk.

Question 7

Contagious runs on bank deposits are directed at FIs, whether they are failing or healthy.

Question 8

A run on a bank is not necessarily a bad occurrence.

Question 9

The use of the option pricing model to determine the actuarially fair premium for deposit insurance indicates that the cost of the insurance should rely on both the asset quality and level of leverage of the DTI.

Question 10

Requiring higher capital ratios often is proposed as method to reduce the incentive to take excessive risk because the moral-hazard risk-taking incentives are thought to decrease as the amount of net worth increases.

Question 11

The Canadian safety net to protect the integrity of the payments system consists of deposit insurance and social welfare.

Question 12

Pricing insurance premiums in an actuarially fair manner involves assessing the risk-taking profile of the financial institution.

Question 13

The policy of forbearance practiced by regulators would allow many banks to remain open even in the face of continuing losses and insolvency.

Question 14

The use of the option pricing model to determine the actuarially fair premium is difficult to apply in practice because the asset values and risks are difficult to determine.

Question 15

The regulatory practice of excessive capital forbearance is a method of reducing the short-run and long-run costs to deposit insurance funds.

Question 16

The cost of insolvency of an FI to CDIC is offset in part by the deposit insurance premiums paid by the bank.

Question 17

Currently in Canada, deposit insurance premiums increase with the amount of risk of the institution.

Question 18

The adverse effects of a contagious run include the restrictions on the ability of individuals to transfer wealth through time and a negative impact on the level or rate of savings.

Question 19

Explicit deposit insurance premiums applied by regulators can involve restricting and more closely monitoring the risky activities of banks.

Question 20

If regulators provide more protection against bank runs, the incidence of moral hazard is likely to increase.

Question 21

Borrowing from the Bank of Canada as lender of last resort is a suitable substitute for deposit insurance and a possible method of preventing bank runs.

Question 22

All of the following are associated with contagious runs EXCEPT

A)liability holders not distinguishing between good and bad FIs.
B)liability holders seeking to quickly turn their liabilities into cash or safe securities.
C)a contractionary effect on the supply of credit.
D)negative social welfare effects.
E)an expansionary effect on the regional money supply.

Question 23

The prompt corrective action program of the FDIC Improvement Act allows a bank or thrift to be placed into receivership when the book value of capital to assets falls below 2 percent.

Question 24

The use of subordinated debt as a replacement for common stock has been proposed as a method of increasing stockholder discipline.

Question 25

The employment of deposit brokers allows individual depositors to receive deposit insurance coverage on total asset balances well in excess of $100,000 at any given bank.

Question 26

The insured depositor transfer method of failure resolution

A)results in the closure of the failed bank.
B)results in the merger of the failed bank into a stronger entity.
C)keeps the failed bank operating for a short period of time.
D)minimizes the deposit insurers' out of pocket costs of resolving a failed DTI.
E)forces insured depositors to bear some losses.

Question 27

The provision of deposit insurance by CDIC is similar to having the CDIC ________ on the assets of the bank that buys the deposit insurance.

A)write a call option
B)buy a call option
C)write a put option
D)having a secondary lien
E)enter into a swap agreement

Question 28

How can the regulators reduce the effects of moral hazard in the absence of depositor discipline?

A)By allowing DTIs to undertake high-risk high-return asset investments.
B)By basing deposit insurance premiums on a DTI's deposit size.
C)By charging explicit deposit insurance premiums and implicit premiums on DTIs.
D)By exhibiting excessive capital forbearance.
E)By implementing prompt corrective action capital zones based on rules rather than discretion.

Question 29

Critics of deposit insurance programs often argue that only uninsured depositors have any incentive to discipline riskier banks.

Question 30

The contagion effect

A)stems from the positive correlation in FI returns.
B)results when interest rate risk increases credit risk and liquidity risk exposures.
C)occurs when liquidity risk problems at bad banks damages well-run banks.
D)occurs when a computer virus infects the computerized electronics payments systems.
E)is completely eliminated by government provided deposit insurance against bank runs.

Question 31

Insured depositors can be covered for more than $100,000 at any given FI under current CDIC regulations.

Question 32

Bank risk taking can be controlled by increasing

A)stockholder discipline by charging stockholders a surcharge.
B)stockholder discipline by setting risk adjusted deposit insurance premiums.
C)depositor discipline by increasing the ceiling for deposit insurance coverage.
D)regulatory discipline by increasing the budgets of the regulatory agencies.
E)depositor discipline by expanding the doctrine of "too big to fail."

Question 33

What is the benefit of a regulatory guarantee or insurance program for liability holders of FIs?

A)It decreases the likelihood contagious runs.
B)It increases concerns about the asset quality of FI.
C)It increases concerns about solvency of an FI.
D)It provides incentives to liability holders to engage in runs.
E)It provides preference to those who are first in line to withdraw funds over those last in line.

Question 34

Risk-based capital supports risk-based deposit insurance premiums by increasing the cost risk taking for DTI stockholders.

Question 35

Which of the following is NOT a social welfare effect of bank runs?

A)Discipline of incompetent managers.
B)Negatively affecting the payments function of DTIs.
C)Reduced availability of credit.
D)Potential decrease in the money supply.
E)Inability to perform intergenerational wealth transfers.

Question 36

Moral hazard at FIs may

A)result when actions and consequences are separated.
B)occur when interest rates are very high and volatile.
C)occur when commodity prices are very high and volatile.
D)be a consequence of strict regulatory supervision.
E)be a consequence of an erosion of family values.

Question 37

Interest rates charged to healthy banks that borrow from the Bank of Canada are typically set one percent below the fed funds target interest rate.

Question 38

One of the overall objectives in using subordinated debt in addition to common stock for a DTI's capital base is to improve market discipline of a DTI's risk structure.

Question 39

Which of the following refers to the regulators' policy of allowing an FI to continue operating even when its capital funds are fully depleted?

A)Capital forbearance.
B)Prompt corrective action.
C)Risk-based deposit insurance.
D)Too-big-to-fail.
E)Regulatory oversight.

Question 40

The "too big to fail" policy doctrine is premised on the separation of small depositors who would receive deposit insurance and large depositors who would not receive the benefits of deposit insurance.

Question 41

The following market value balance sheet of a failed bank ($ millions) What is the market value of capital?

A)$200 million.
B)-$200 million.
C)$0.
D)$400 million.
E)$600 million.

Question 42

Which of the following is a drawback of charging flat deposit insurance premiums?

A)The deposit insurer acts more like a private property & casualty insurer when charging flat premiums.
B)It discourages banks from taking risks.
C)Both high risk and low risk banks are charged the same premium rate.
D)High risk banks will be charged an unreasonably high premium rate.
E)Premiums reflect the expected private costs or losses to the insurer from the provision of deposit insurance.

Question 43

When risk-taking is not actuarially fairly priced into deposit insurance premiums

A)depositors are required to pay the shortfall in funds collected.
B)there is an increase in the incentives for owners of DTIs to take additional risk.
C)deposit insurance premiums are more costly than economically justified.
D)depositors will be unprotected should the DTI become insolvent and fail.
E)the insurance provider is forced to find other sources of funds to continue coverage for the institution.

Question 44

The following market value balance sheet of a failed bank ($ millions) If the insured depositor transfer resolution method is utilized, what is the cost to insured depositors of bank failure resolution?

A)$0.
B)-$200 million.
C)$67 million.
D)$133 million.
E)$200 million.

Question 45

The system of flat deposit insurance premiums:

A)enhances bank safety and soundness because it discourages bank risk taking.
B)reduces bank safety and soundness because it encourages bank risk taking.
C)has no impact on bank safety and soundness.
D)places banks that are considered "too big to fail" at a disadvantage.
E)provides unfair advantage to small banks.

Question 46

The following market value balance sheet of a failed bank ($ millions) If the insured depositor transfer resolution method is utilized, what is the cost to uninsured depositors of bank failure resolution?

A)$0.
B)-$200 million.
C)$67 million.
D)$133 million.
E)$200 million.

Question 47

As a result of loan write-offs, Bank A has to be liquidated by the regulators. The book value of the assets and liabilities of the bank is presented below (in millions of dollars). The market value of the loans has been estimated at $240 million. What is the cost to the insured depositors if the insured depositor transfer resolution method is used by the regulators to resolve the bank failure?

A)$0.
B)$100 million
C)$30 million.
D)$40 million.
E)$60 million.

Question 48

Under the option pricing model of deposit insurance, the cost of the insurance

A)decreases as the insured deposit base increases.
B)decreases as the period over which the insurance coverage extends is increased.
C)increases with the level of risk of the assets held by the DTI increase.
D)decreases with market interest rates.
E)increase as the level of leverage used by the DTI decreases.

Question 49

As a result of loan write-offs, Bank A has to be liquidated by the regulators. The book value of the assets and liabilities of the bank is presented below (in millions of dollars). The market value of the loans has been estimated at $240 million. What is the cost to the CDIC if the insured depositor transfer resolution method is used by the regulators to resolve the bank failure?

A)$0.
B)$20 million.
C)$30 million.
D)$40 million.
E)$60 million.

Question 50

The following market value balance sheet of a failed bank ($ millions) If the insured depositor transfer resolution method is utilized, what is the cost to the CDIC of bank failure resolution?

A)$0.
B)-$200 million.
C)$67 million.
D)$133 million.
E)$200 million.

Question 51

Subordinate debt (SD) has been proposed as a means of increasing the degree of overall market discipline at a depository institution. Which of the following objectives is considered to be achievable when attempting to increase market discipline?

A)Issuing SD might increase the size of the DTI's capital cushion.
B)The expected cost of issuing SD should decrease as the risk of the DTI increased.
C)Mandatory SD would reduce transparency at DTIs.
D)SD would further emphasize the use of capital forbearance.
E)Secondary market yields on the SD would be inversely related to an increase in the risk of the DTI.

Question 52

As a result of loan write-offs, Bank A has to be liquidated by the regulators. The book value of the assets and liabilities of the bank is presented below (in millions of dollars). The market value of the loans has been estimated at $240 million. What is the current net worth (market value) of the bank?

A)+$40 million.
B)$0 million.
C)-$40 million.
D)-$60 million.
E)-$100 million.

Question 53

As a result of loan write-offs, Bank A has to be liquidated by the regulators. The book value of the assets and liabilities of the bank is presented below (in millions of dollars). The market value of the loans has been estimated at $240 million. What is the cost to the uninsured depositors if the insured depositor transfer resolution method is used by the regulators to resolve the bank failure?

A)$0.
B)$20 million.
C)$30 million.
D)$40 million.
E)$60 million.

Question 54

Deposit insurance contracts can be structured to reduce moral hazard behaviour by

A)increasing depositor discipline.
B)increasing stockholder discipline.
C)increasing regulator discipline.
D)reducing owner incentives to take risks.
E)All of these.