Complete Flashcards
Give an Historical insight of Bank Runs
1620: Thirty Years War
* German city-states minted imitations of rival cities coins using lesser metals
1772: Financial Haggis (UK)
* Scottish bank had lost customer money in risky speculation. Triggered chaos that took down almost all of the country’s private banks. Inspired the parliament to pass the Tea Act.
1873: The Great Freakout
* Customers demanded gold for cash. Economic crisis. US sent army to war with Native Americans in area with gold
1914: Schwenk Ban run (New York)
* State banking regulators seized three banks owned by Schwenk, due to dodgy accounting.
1930s: The Great Depression
* Over 9,000 banks collapsed
1980: Savings-and-Loan Crisis (US)
2001: Great Depression of Argentina (Malos Aires)
* Not enough dollar to cover all deposits. Had to put restrictions on withdrawal
2011-present: Greece (EuroBlown)
* High public spending, big debt
* A quarter of all deposits have been pulled from Greek banks over two years
What happened after stock market crash of October 1929 in US
- Wealthy people pulled out money from banks
- Less capital available = less capital for businesses and individuals
- Less capital for businesses and individuals = decline in production and employment
- Wave of Bank runs
What will a bank have to do in the case of a bank run?
The bank needs to come up with the necessary cash:
a) Liquidate loans (sell the loans, securitize them, borrow from a central bank)
b) Sell assets (often at rock-bottom prices)
Who was the president during the Great depression, and what did he do to end it?
Franklin D. Roosevelt
a) National Bank Holiday (Temporarily closure to access their solvency)
b) New Banking Legislation: The Emergency Banking Act of 1933 (aimed to separate good and bad banks)
c) The New Deal. For employment
d) Spoke on Radio: Public confidence “fireside chats”
Lehman Brothers. Size and timeline
- Fourth largest U.S Investment Bank
1. Buying the Bubble: Aimed to profit from booming housing market. Acquired several mortgage lenders.
a) Subprime Loans: offered to those with low creditworthiness
b) Alt-A Loans: A Type of mortgage loan. Lower income and less documentation required. Slightly better than Subprime, but still risky
2. Securitizing Mortgage Loans: Pooled them and sold them
3. Big profits from 2005 – 2007 - 2007: Underwrote more mortgage-backed securities than any other firm
- BNC: A Subprime mortage lender that was a subsidiary of Lehman. Known for its aggressive lending practices – offering many subprime mortgages – Which was pooled together and sold.
4. Increased its leverage.
5. Crisis:
a) Heavy investments in subprime mortgage market
b) High degree of leverage
6. Measures after crisis
a) Shut down BNC
b) Closed offices of Alt-A lender Aurora
c) Positive Public messages from CFO
7. After Korean Bank
a) Big plunge in Stock
b) Big increase in credit-default swaps on the company’s debt (shows investors confidence)
c) Hedge Fund clients started to withdraw their investments
d) Short-term creditors cut credit lines
Bankruptcy in September 2008
How to stop a Bank Run or Panic (Explanation, Example, Disadvantage)
(BLESIC)
a) Suspension of Convertibility
* Example: Roosevelt, 1933: National Bank Holiday
* Disadvantages:
Stops people who genuinely need money to withdraw.
Not easy to do today (digital banking)
b) Coalition of Private Banks
* Example: Northern Rock, 2008 – Barclays, Lloyd, Royal Bank of Scotland)
- “clearinghouse loan certificates”: Short term loans or promissory notes backed by the collective resources of the coalition banks
* Disadvantage: If all banks are suffering from common shock, it does not work
c) Government Deposit Insurance
* Example: 1934: Federal Deposit Insurance Corporation (FDIC)
- The government insure the people that they will give the people their money in case of bankruptcy
* Disadvantage:
Moral Hazard: Depositors feel that they don’t have to monitor the banks. So banks are not restricted from taking higher risks. Hence, the bank can take higher risk by lending out more money.
Too-Big-To-Fail: Banks covered by Deposit Insurance. Failure of a covered bank can trigger a chain reaction. Banks owe money to each other
d) Capital Requirement and Cash Requirement (always)
- A bank has to hold an amount of reserves. Often as a ratio of equity that must be held as a percentage of risk-weighted assets.
i) Bank cannot take too much leverage
ii) Bank have liquid funds in times of financial distress
* Disadvantage: Reduces the efficiency of a bank’s use of money and hence increases the costs of credit for the entire economy
e) Lender of Last Resort
* Example: Reichsbank, 1914: Schwenk. Also, many in 2008)
- Bank run will stop if people are not afraid that the bank will run out of money. Hence, central banks can back up private banks.
* Disadvantage:
Moral Hazard: Banks might take higher risks (can rely on central)
Financial Risk: Central Bank can be exposed to significant financial risk
Blurring the Boundaries: Blur boundary between monetary and fiscal policy. By giving money, gets involved in fiscal matters
f) Government Bailouts (2008: Several governments, U.S: TARP)
- Government aims to raise Credit Availability:
i) Liquidity injection: Asset purchase, Debt guarantee or Direct Debt (Provide immediate funds to address short term liquidity)
ii) Equity Injection (Acquiring ownership by buying newly issued preferred stocks)
* Disadvantage: Too-Big-To-Fail creates Moral Hazard. Signals to market that risky banks will be saved regardless of risky behaviour
g) Equity Injections
* Example: 2011: Government and International institutions provided equity to Greece)
How did they raise Credit Availability in 2008?
(CRID)
a) Removing Poisonous Assets:
* Programs like TARP, where government bought troubled assets, like mortage-backed securities from financial institutions
b) Debt Guarantee:
* Government pays debt for another party. Makes it easier for banks to do liquidity things.
c) Relaxing the requirement of collateral
* Bank gets to access funding by using a broader range of assets as collateral (also those who might have lost value)
d) Increase Borrowers Net Worth:
* Individuals and Businesses. Financial Assistance
What is the Diamond Dybvig Model
- Model of bank runs and related to financial crises.
- Shows how a mix of these components may create panics by depositors:
a) Illiquid assets (like mortgage loans)
b) Liquid liabilities (deposits which may be withdrawn at any time)
What are the General Principles of Bank Regulation
(MLM)
a) Licensing and supervision
Banks usually need banking license from national bank.
The regulator supervises licensed banks
b) Minimum Requirements
National bank imposes requirements for banks, often closely tied to the level of risk exposure.
Most important: Maintaining minimum capital ratios
c) Market Discipline
Banks must publicly disclose financial statements
What are the Instruments and Requirements of Bank Regulation
(FCC CARL)
a) Capital Requirement
- How banks must handle their capital in relation to their assets
b) Reserve Requirement
- Lost the role it had, as the emphasis has moved to capital adequacy
c) Corporate Governments (Encourage bank to be well managed)
- Legal entity, number of directors, organization structure
d) Financial reporting and disclosure requirements
- Requirement of disclosure of banks finances
e) Credit Rating Requirement
- May be required to obtain credit rating given by credit rating agency
f) Large exposures restrictions
- Prevent banks from having overly large financial exposures to specific individuals or groups of related individuals
g) Activity and Affiliation
- Limit activities banks can engage in and the relationship they can have with other financial institutions
FED Controversy
- Lending to private firms, hence putting taxpayers money at risk
- Could avoid these problems by not lending to private firms
What was BNC
A Subprime mortage lender that was a subsidiary of Lehman. Known for its aggressive lending practices – offering many subprime mortgages – Which was pooled together and sold.
How much involved did Lehmann get in the mortgage market in 2007
In 2007 they underwrote more mortgage-backed securities than any other firm
Why has Europe never had to use the Suspension of Convertibility?
Banks have not ran out of money because of Lender of Last Resort. Commercial banks have borrowed money from the European Central Bank.
What is a clearinghouse?
A “middle-man” between buyer and seller.
What is “clearinghouse loan certificates”?
Short term loans or promissory notes backed by the collective resources of the coalition banks
Why did central banks emerge?
Evolved as a response to the inability of the commercial banks to cope with panics
Where can you find Deposit Insurance today, and how does it work?
Most countries in Europe.
(But also USA I believe (?))
Similarities between collapse of Lehman Brothers and “normal” bank runs?
- Underlying reasons are similar
1. Institutional investors stops funding the bank
2. Due to liquidity problems Bankruptcy
What is one solution that has been proposed to the risk of Deposit Insurance?
Deposit insurance backed by the whole eurozone.
Taxpayers of Germany would have to pay for financial stability in Greece.
How will Capital Requirement usually be expressed?
As a ratio of equity that must be held as a percentage of risk-weighted assets.
Why are Capital/Cash requirements put into place?
Often as a ratio of equity that must be held as a percentage of risk-weighted assets.
This is good because:
a) Bank cannot take too much leverage
b) Bank have liquid funds in times of distress
Bank ru: Liquidity injection through ….?
Asset Purchase
Debt Guarantee
Direct Debt
What is the main argument for Bank Regulation?
Too-Big-To-Fail
certain banks, due to their size, complexity, or interconnectedness with the financial system, pose a significant risk to the overall economy if they were to fail
What are the different types of banks
a) Central Banks
b) Commercial Banks
c) Investment Banks
Main Tasks of Central Bank
a) Control the nations money supply
b) Oversee the commercial banks
What are the different Banking Services
a) Individual Banking - help people to manage their finances
b) Business Banming - Business gets different type of service
c) Digital Banking - Digital services
What are the Main Policy Tools of Central Banks (in controlling money supply)
a) Open market operations
* Buy and sell securities in the open market.
- Buying securities = injecting money
- Selling securities = withdrawing money
b) Lender of Last Resort:
* Central bank’s role as a source of funding for banks and other financial institutions during times of financial stress or crisis
c) Minimum reserve requirements:
* Amount of money that banks are required to hold in reserve.
- By adjusting, central banks can control the amount of money banks have available to lend
d) Monetary Policy (Interest rate etc.)
* The rate which banks can borrow from the central bank
- Courage or discourage banks from borrowing, which in turn affects amount of money in economy
What is the interbank market? Purpose & rates
A Debt market among banks. Is used to:
a) Manage liquidity (may need to borrow from other banks on a short-term basis to meet liquidity needs)
b) Satisfy regulations (such as reserve requirements)
Uses FED-rate, Euribor or LIBOR
