Chapter 10: Innovation and Structure in Banking and Finance
True/False
1) In the past, excessive competition led to a low rate of innovation within the banking industry.
2) The 6 in the 3-6-3 rule refers to the interest rate on assets.
4) Unit banks are banks that operate in only one state.
5) Unit banks have no branches.
6) Unit banks often had local monopolies, meaning they had little incentive to innovate.
7) Banks operating in more than one state used to be illegal.
8) Banks chartered by the Federal government are called national banks.
9) One of the 3s in the 3-6-3 rule refers to the interest rate on assets.
12) Regulation Q (the restriction on interest paid on deposits) was responsible for the rise in nominal interest rates in the 1970s.
13) Loophole mining is a way for banks to get around regulations.
14) SWEEP accounts allow banks to make interest on reserves.(T)
15) SWEEP accounts allow deposit rate to adjust with market rates.(F)
16) SWEEP accounts are an example of loophole mining.
20) Regulation Q (the restriction on interest paid on deposits) and rising nominal interest rates during the Great Inflation were responsible for an increase the size of the mutual fund industry.(T)
21) Interest payments from commercial loans are an increasingly important source of bank profits.
22) The Great Inflation eventually led to an increase in bank profits.
23) The Herfindahl index is a measure of banking innovation.
24) According to the Herfindahl index, the United States has one of the most concentrated banking industries in the world.(F)
25) According to the Herfindahl index, the U.S. banking industry has become increasingly concentrated in the last few decades.

27) Commercial banks are the only institutions in the United States that take transactions deposits.
28) The process of bundling loans and selling pieces of the group is known as securitization.
29) Junk bonds are an example of a securitized asset.
30) Mortgage backed assets are an example of a securitized asset.
32) Government regulation is relatively permissive in the United States compared to other countries.
Multiple Choice
1) Unit banks a) have no branches. b) have a local monopoly. c) had little incentive to innovate. d) all of the above.
2) Unit banks a) have no branches. b) are highly competitive. c) are an increasingly common type of financial institution. d) all of the above.
3) Which of the following is an example of disintermediation? a) money market mutual funds b) insurance companies c) interest-only mortgages d) all of the above
5) The Great Inflation affected the banking industry through the following channels. a) higher nominal interest rates b) decline in deposits c) increase in disintermediated borrowing d) all of the above
6) The Great Inflation affected the banking industry through the following channels. a) lower nominal interest rates b) decline in deposits c) decreased competition among banks d) all of the above

7) ARMs a) force borrowers to assume interest rate risk. b) became more prevalent during the Great Inflation. c) both of the above. d) neither of the above.
8) ARMs a) force lenders to assume interest rate risk. b) became more prevalent during the Great Inflation. c) both of the above. d) neither of the above.
9) With an ARM, who must take on the interest rate risk? a) borrower b) lender c) both d) neither
10) Bank holding companies allows bankers to circumvent a) Regulation Q. b) interstate banking restrictions.
c) reserve requirements. d) none of the above.
11) Technology has helped to make possible which of the following innovations? a) ATMs b) credit cards c) mortgage backed securities d) all of the above
12) Securitization has allowed some banks to concentrate on a) origination of loans. b) credit risk. c) specialized lending. d) all of the above.
13) Which of the following do NOT generate fees for banks? a) credit cards b) securitized loans c) reserves d) They all generate fees.
14) Which of the following do NOT generate fees for banks? a) credit cards b) securitized loans c) ATMs d) They all generate fees.

16) Bank consolidation is potentially a problem because a) larger banks are harder to regulate. b) a failure of a large bank has a big effect on the economy. c) both of the above. d) neither of the above.
(c, easy, section 5)
17) Bank consolidation is potentially a problem because a) it is harder for large banks to implement technological innovations. b) some consumers may get worse service. c) banks are less able to innovate. d) all of the above.
18) Bank consolidation is potentially a problem because a) larger banks tend to be more diversified. b) larger banks tend to take greater risks. c) both of the above. d) neither of the above.
19) Bank consolidation is desirable because a) small banks with little capital are eliminated. b) banks are more diversified. c) both of the above. d) neither of the above.
20) Bank consolidation is desirable because a) banks are able to do specialized lending. b) banks are more diversified. c) banks are more able to serve small business. d) all of the above.
21) Which of the following is a measure of bank consolidation? a) Regulation Q b) The Gini coefficient c) The Herfindahl index d) The Greenspan index
22) According to the Herfindahl index, the U.S banking industry is _____ concentrated than that of most developed economies. a) more b) less c) equally d) The Herfindal index is not a measure of concentration.
24) The erosion of Glass-Steagall allowed financial institutions to take advantage of a) economies of scale. b) economies of scope.

c) interstate banking. d) all of the above.
25) Regulators do not consider a financial institution to be a bank if it does not a) take deposits. b) borrow from the Fed. c) both of the above. d) neither of the above.
27) Which of the following changes or innovations does NOT depend on computer technology? a) banker’s acceptances b) ATMs c) SWEEP accounts d) They all depend on computer technology.
Short Answer
1) What is a unit bank?
2) What is a national bank?
3) Why is commercial paper an example of disintermediation?
Commercial paper are loans between businesses that don’t involve a bank or financial institution.
4) What regulation do SWEEP accounts circumvent? How do banks benefit?
SWEEP accounts get around the reserve requirement by reducing the amount of transactions deposits. Banks can now convert those reserves to interest bearing assets.
5) What type of regulation did holding companies circumvent?
Holding companies got around the ban on interstate banking.
7) How did a lack of competition among banks give rise to mutual funds?
The lack of competition meant that banks paid low interest rates on deposits, so consumers had incentive to seek out institutions such as mutual funds that paid higher returns.
9) What is the advantage of online banking for banks?

lower costs.
10) The Erosion of Glass-Steagall has allowed financial institutions to take advantage of economies of scale or scope. Explain.
Financial institutions can now engage in multiple areas such as insurance and brokering while taking deposits like a traditional bank, primarily taking advantage of economies of scope.
11) Why would larger banks be less risky?
Large banks can have more diversified assets (and liabilities).
12) Why would larger banks be a problem for regulators?
Larger banks might be considered too big to fail, so they have incentive to take excessive risks.