Chapter 11: The Economics of Financial Regulation
True/False
19) Basel recommendations are not binding on regulators.
20) The Basel accords put more emphasis on assessing the risk of assets.
21) The Basel accords provide extra guards against bank runs.
(F)
25) The Glass-Steagall Act was a key part of the stabilization of the financial sector
during the Great Depression.
26) The S in CAMELS stands for sensitivity to risk.
27) The C in CAMELS stands for credit risk.
28) The Gramm-Leach-Bliley legislation outlawed interstate banking.
29) The Gramm-Leach-Bliley legislation overturned Glass-Steagall.
31) The main reason for financial system regulation is market failure.
Multiple Choice
7) Which of the following contributed to falling profits for banks in the 1970s and early
1980s?
a) Regulation Q
b) high inflation
c) competition from mutual funds
d) all of the above
8) Which of the following are recommendations for banking regulation of the Basel
accords?
a) Assess the risk of different assets.
b) Raise the importance of the leverage ratio.
c) Allow switching of accounting techniques in a crisis.
d) All of the above.
15) Which of the following pieces of legislation eased the barriers between banks and
insurance companies?
a) Glass-Steagall
b) FIRREA
c) FDICIA
d) none of the above
16) The Gramm-Leach Bliley legislation overturned
a) the McFadden Act.
b) the Glass-Steagall legislation.
c) the Riegle-Neale Act.
d) all of the above.
17) The L in CAMELS stands for
a) liability
b) liquidity
c) labor
d) none of the above
18) Off-balance sheet activities worsen the asymmetric information problem between
a) banks and regulators.
b) regulators and politicians.
c) politicians and the public.
d) none of the above.
21) Basel II gave more sophisticated guidelines for judging _____ than Basel I.
a) asset quality
b) capital adequacy
c) liquidity
d) all of the above
22) Basel II’s third pillar refers to
a) judging asset quality.
b) financial market marketing.
c) leverage ratio calculation.
d) none of the above.
23) The most beneficial government reaction to the Great Depression was
a) lowering interest rates.
b) raising tariffs.
c) creating the FDIC.
d) raising the reserve requirement.
25) The creation of the SEC was intended to increase _____ in financial markets.
a) profits
b) transparency
c) credit risk
d) liquidity
26) The FDIC was created in response to
a) bank runs.
b) zombie S&Ls.
c) the stock market crash.
d) WWII.
Short Answer
14) The creation of the FDIC had immediate benefits and long term costs. Describe both
and how they relate to asymmetric information.
The immediate benefit of deposit insurance was to stop bank runs that were
causing bank failures during the Great Depression. Deposits were taken out of healthy
banks because depositors did not have sufficient information to know their risk. The
FDIC insurance removed the need to know. The difficulty with deposit insurance is that it
removes the incentive for depositors to monitor the banks. Banks take more risk than they
should, since regulators don’t have sufficient information to judge the risk of the banks.
15) The FDICIA helped to solve a moral hazard problem between regulators and banks.
Explain.
Banks know more about their viability than regulators, so they can get regulatory
forbearance to let them operate through insolvency. The FDICIA makes such
forbearance illegal. Regulators must deal with insolvent banks using the lowest cost
method.
17) What does CAMELS stand for?
capital adequacy, asset quality, management, earnings, liquidity, sensitivity to
risk