Aryan Gupta Finance Professor Tully 22 February 2022 Chapter 3 8. (LO 3.5) Why was it considered necessary to create the Federal Reserve System when we already had the benefits of the National Banking Act? - The Federal Reserve Act of 1913 established a central Banking system in the United States. The Federal Reserve System was designed to eliminate many of the weaknesses that has persisted under the National Banking Act and to increase the effectiveness of commercial banking in general. It included not only strong central domination of banking practice but also many services for commercial banks. 14. (LO 3.5) How are depositors’ funds protected today in the United States? - The Federal Deposit Insurance Corporation (FDIC) was created in 1933 to protect deposits in banks. The FDIC is an independent federal agency insuring deposits in U.S. banks and thrifts in the event of bank failures. Today, the FDIC insures up to $250,000 per depositor which guarantees consumers that their money is safe as long as it is within the limits and guidelines. 16. (LO 3.7) What are the major asset categories for banks? Identify the most important category. What are a bank’s major liabilities and stockholders’ equity, and which category is the largest in size? - The principal assets of banks and other depository institutions are cash assets, securities owned, loans, and bank fixed assets. Bank assets are mainly in the form of cash and balances due from depository institutions, securities, loans, and fixed assets. Most assets are held in the form of loans. securities are major part of the bank’s assets and account for one fifth of total assets. Loans account for three fifths of the bank assets, making this the most important account category. A banks common equity equals stockholders' equity unless preferred stock has been issued by the bank. Common equity includes the proceeds from the sale of common stock plus the banks retained earnings accumulated over time. 17. (LO 3.8) What is meant by bank liquidity and bank solvency? - Bank liquidity reflects the ability to meet depositor withdrawals and to pay off other liabilities when they come due. The inability to meet withdrawal and debt repayments results in bank failure. Liquidity risk is associated with higher bank safety and generally lower bank profits. To decide how much liquidity risk is appropriate, managers make asset management and liability management decisions. Adequate capital is needed to ensure that a bank remains solvent, meet depositor demands and pay their debts as they come due. Bank solvency imitates the ability to keep the value of a bank's assets greater than its liabilities. A bank is considered solvent if its assets are worth more than its liabilities. 18. (LO 3.8) Describe how assets are managed in terms of a bank’s liquidity risk. Also, briefly describe how liquidity management is used to help manage liquidity risk. - Liquidity management is the management of a bank’s liquidity risk, which is the likelihood that the bank will be unable to meets its depositor withdrawal demands and/or other liabilities when they are due. Lower liquidity risk is associated with higher banks safety and generally lower bank profits. The opposite case is when bank managers choose to take on greater liquidity risk to improve profits. 19. (LO 3.8) Describe what is meant by liquidity risk, credit risk, and interest rate risk. - Liquidity risk likelihood that a bank will be unable to meet depositor withdrawal demands and other liabilities when due. - Credit risk (default risk) the chance of nonpayment or delayed payment of interest or principal. - Interest rate risk possible price fluctuations in fixed rate debt instruments associated with changes in market interest rates. 20. (LO 3.8) Define and describe the following terms: common equity capital ratio, tier 1 ratio, and total capital ratio. How are these used by bank regulators? - Common equity capital ratio = Common equity / Total assets * 100 - Tier 1 capital is composed of common equity, noncumulative preferred stock, and trust preferred stock to investors, minus intangible assets. Tier 1 ratio = tier 1 capital / Risk adjusted assets * 100 - Total capital Ratio = (Tier1+ Tier 2 Capital) / Risk adjusted assets * 100 - To be considered adequately capitalized a bank needs to have a 6% tier 1 capital ratio and an 8% total capital ratio. Chapter 4 8. (LO 4.3) How are members of the BOG of the Federal Reserve System appointed? To what extent are they subject to political pressures? - Composed of seven members and are appointed for a term of 14 year. The 14-year term is to reduce political pressure on the BOG. The board member thus can be from any political part and there are no special requirements for members. All members are appointed by the president with the help and advice of the senate. The BOG is in fact one of the most powerful monetary organizations in the world and the chair of the board plays an especially influential role in policy formation. Because the board is unbiased there are sometimes disagreements between parties and time to time there is pressure from congress, or the president have undoubtedly influenced the decisions. 14. (LO 4.4) Reserve Banks have at times been described as bankers’ banks because of their lending powers. What is meant by this statement? - They are seen as banker’s bank because the Fed serves as a lender to depository institutions. Banks can go to the Fed’s discount window and borrow funds to meet reserve requirements, depositor withdrawal demands, and even business loans demand. The Fed as well does check clearance and collection which is an import task for banks. 16. (LO 4.5) Explain the usual procedures for examining national banks. How does this process differ from the examination of member banks of the Federal Reserve System holding state charters? - National banks are subject to inspection by the Comptroller of the Currency, the Federal Reserve System, and the Federal Deposit Insurance Corporation. Although in practice, national banks are rarely examined by the staff of the Federal Reserve System to avoid overlapping examining authority, so the report by the Comptroller of the Currency is forwarded to the Reserve Bank of the area. Federal Reserve Banks direct their major attention to examining state-chartered member banks of the districts. State-chartered banks are not subject to the investigation of the Comptroller of the Currency, however, are subject to the laws of the states in which they are chartered, as well as the Federal Reserve System and FDI. The OCC direct more of its attention to nationally chartered banks, while the FDIC supervises insured nonmember commercial banks. 17. (LO 4.5) What federal agencies are responsible for supervising and regulating depository institutions that are not commercial banks? - The National Credit Union Administration supervises and regulates credit unions, and the office of Thrift Supervision oversees S&Ls and other savings institutions 18. (LO 4.5) Describe the objectives of the Consumer Credit Protection Act of 1968. What is the Truth in Lending section of the act? What is Regulation Z? - 19. (LO 4.6) Explain the process by which the Federal Reserve Banks provide the economy with currency and coin. 20. (LO 4.6) Describe how a check drawn on a commercial bank but deposited for collection in another bank in a distant city might be cleared through the facilities of the Federal Reserve System.