Deck 19: Deposit Insurance and Other Liability Guarantees

Question 1

As a result of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), the deposit insurance fund for the savings and loan industry has been combined with the deposit insurance fund for the commercial banking industry.

Answer 1

False

Question 2

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

Answer 2

True

Question 3

Since its inception, the FDIC deposit insurance fund has never fallen to a negative balance.

Answer 3

False

Question 4

During the financial crisis of 2008-2009, deposit balances at DIs increased.

Question 5

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

Question 6

The number of bank failures in the period of 1933-79 was less than the number of failures from 1980-1989.

Question 7

After nearly failing, the FDIC's Bank Insurance Fund (BIF) achieved record levels of reserves during the 1990s.

Question 8

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

Question 9

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

Question 10

A major reason for the deterioration of the deposit insurance funds in the 1980s was the downturn in the technology, manufacturing, and real estate industries.

Question 11

The average cost to the FDIC of each bank failure during the decade of the 1980s was larger than the total cost of all bank failures during the period 1933-79.

Question 12

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

Question 13

The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) restructured the savings association deposit insurance fund and transferred its management to the FDIC.

Question 14

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

Question 15

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

Question 16

A major cause of the FSLIC insolvency in the 1980s was the dramatic rise in interest rates in 1979-82 that created extensive duration mismatches of assets and liabilities in the savings and loan industry.

Question 17

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

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

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

Question 20

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

Question 21

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

Question 22

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 23

The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) required the FDIC to establish risk-based premiums for deposit insurance coverage at banks.

Question 24

Because deposit insurance premiums were not priced in an actuarially fair manner during the period from 1933-1980s, instability was created in the credit and monetary system.

Question 25

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

Question 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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 DI.

Question 31

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

Question 32

The Designated Reserve Ratio is a rule that stipulates that highly-rated DIs would not pay deposit insurance premiums if this ratio was above 1.25 percent.

Question 33

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 34

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

Question 35

The policy of forbearance practiced by the FSLIC in the late 1980s allowed many commercial banks to remain open even in the face of continuing losses and insolvency.

Question 36

The improved financial health of the FDIC during the 1990s resulted in a considerable reduction in deposit insurance premiums.

Question 37

The ability of the FDIC to place a bank into receivership even though the book value of capital remains positive is an attempt to institute increased stockholder discipline.

Question 38

The initial risk-based deposit insurance program implemented on January 1, 1993 was based on capital adequacy and supervisory judgments involving asset quality, loan underwriting standards and other operating risks.

Question 39

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

Question 40

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 41

The discount window at the Federal Reserve is a suitable substitute for deposit insurance and a possible method of preventing bank runs.

Question 42

The insured depositor transfer method of least-cost bank failure resolution requires the FDIC to employ the method that imposes the highest amount of failure costs on uninsured depositors.

Question 43

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 DIs.
C)Reduced availability of credit.
D)Potential decrease in the money supply.
E)Inability to perform intergenerational wealth transfers.

Question 44

The "too big to fail" policy doctrine prevalent through the 1980s and most of the 1990s is remised on the separation of small depositors who would receive deposit insurance and large depositors who would not receive the benefits of deposit insurance.

Question 45

The 1993 Depositor Protection legislation gives equal claim to the value of liquidated assets less the amount of insured deposits to foreign uninsured depositors, domestic uninsured depositors, and the FDIC.

Question 46

The introduction of prompt corrective action capital zones by FDICIA was an attempt to place greater decision-making power at the discretion of regulators rather than on objective, measurable rules.

Question 47

The required contribution from surviving insurers to protect policyholders of failed insurance companies usually is on a pro rata amount based on the relative asset size of the surviving company.

Question 48

The employment of deposit brokers allows individual depositors to receive deposit insurance coverage on total asset balances well in excess of $250,000 at any given bank.

Question 49

The deposit insurance programs of the National Credit Union Administration (NCUA) is modeled after the programs offered by the FDIC.

Question 50

During the 1980s, a high proportion of brokered deposits at a DI became an early warning signal of its risk for failure.

Question 51

FDICIA imposed additional regulatory discipline as a substitute for increased stockholder and depositor discipline.

Question 52

The deficit realized by the PBGC in 1992 was a result of risk-taking by fund administrators.

Question 53

The Pension Benefit Guaranty Corporation (PBGC) insures pension benefits against the under-funding of pension plans by corporations.

Question 54

The FIRREA prohibited all insured financial institutions from accepting brokered deposits or paying interest rates that are significantly higher than existing market rates.

Question 55

Insured depositors can be covered for more than $250,000 at any given FI under current FDIC regulations.

Question 56

State guaranty funds for insurance companies are sponsored by state insurance regulators rather than by a federal agency such as the FDIC.

Question 57

By decreasing the use of the discount window as a source of funding for a DI, the Federal Reserve hopes to reduce volatility in the fed funds market.

Question 58

Interest rates charged to healthy banks that use the Federal Reserve discount window are typically set one percent below the fed funds target interest rate.

Question 59

The FDIC deposit insurance program is also available to credit unions.

Question 60

The National Credit Union Administration (NCUA) is an independent federal agency that insures credit union deposits.

Question 61

The system of flat deposit insurance premium formerly used in the U.S.

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 community banks.

Question 62

Which of the following methods was NOT a method used to replenish the FDIC's deposit insurance reserve fund during the most recent financial crisis?

A)A special assessment was imposed on participating FIs in early 2009.
B)Individual depositor insurance coverage was increased to $250,000.
C)Deposit insurance premiums were increased.
D)Participating institutions were required to pre-pay insurance premiums.
E)A special assessment was imposed on participating FIs during the fall of 2009.

Question 63

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

A)The FDIC 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 64

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 65

The provision of deposit insurance by the FDIC is similar to having the FDIC ________ 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 66

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 DIs to take additional risk.
C)deposit insurance premiums are more costly than economically justified.
D)depositors will be unprotected should the DI become insolvent and fail.
E)the insurance provider is forced to find other sources of funds to continue coverage for the institution.

Question 67

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 DI's capital cushion.
B)The expected cost of issuing SD should decrease as the risk of the DI increased.
C)Mandatory SD would reduce transparency at DIs.
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 DI.

Question 68

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 69

Which of the following refers to mandatory actions that have to be taken by regulators as a DI's capital ratio falls.

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

Question 70

From January 2008 to December 2009, there were a total of ____ FDIC insured bank failures, which cost the FDIC approximately ____ billion to resolve.

A)26; $17
B)140; $39
C)166; $56
D)211; $69
E)234; $72

Question 71

What was the objective of the FDIC Improvement Act (FDICIA) of 1991?

A)Returning the banking industry to record profit levels.
B)Restructure the savings association deposit insurance fund and transfer its management to FDIC.
C)To deny deposit insurance coverage to funds obtained through deposit brokers.
D)To restructure the bank deposit insurance fund and prevent its potential insolvency.
E)To enforce the capital standards on insured depository institutions.

Question 72

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 73

To address the decreasing balance of the FDIC deposit insurance fund during the financial crisis of 2007-2008

A)deposit insurance programs were suspended for a period of three months.
B)the FDIC increased individual depositor insurance coverage from $100,000 to $250,000.
C)the FDIC announced that it would no longer honor deposit insurance coverage of some failing DIs.
D)two special assessments were levied on institutions participating in the FDIC insurance programs.
E)the U.S.Treasury had to take over management of the FDIC.

Question 74

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 75

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

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

Question 76

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 FDIC's out of pocket costs of resolving a failed DI.
E)forces insured depositors to bear some losses.

Question 77

What does a high proportion of brokered deposits indicate?

A)Total risk-based capital ratio of the DI is less than 10 percent.
B)Above average risk, and thus an increased potential for failure.
C)Less informed savers are protected against a reduction in wealth.
D)Reduced insolvency risk as brokered deposits are covered under deposit insurance.
E)Lower levels of credit risk.

Question 78

Which of the following contributed the least to the collapse of the FSLIC/FDIC deposit insurance funds?

A)An increase in interest rate volatility.
B)Enhanced investment powers granted to thrifts.
C)Fraudulent behavior induced by the greed of the decade of the 80s.
D)Fraudulent behavior induced by ineffective regulatory incentives.
E)The extension of deposit insurance to uninsured depositors.

Question 79

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 80

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 Fedwire and CHIPS.
E)is completely eliminated by government provided deposit insurance against bank runs.