Bank Failure Flashcards
What are the 2 ways a bank may fail (bank run)?
Liquidity crisis.
This is where theres not enough short term assets to meet short term liabilities. This causes panic, leading to a bank run.
Insolvency.
This is where there’s not enough capital to offset losses in asset values. This leads to a situation where liabilities are greater than assets. So they owe more than what is owns. It leads to insolvency.
What are short term liabilities and short term assets?
ST Liabilities: deposits and short term borrowing.
ST Assets: cash, reserves at BOE, cash at short notice, ST investments.
What is the main risk of bank failure? and give an example how
Systemic risk.
This is where the collapse of one bank can harm the whole financial industry.
eg: If other banks have assets that the failing bank owns, then they will lose this asset. They must have enough capital to cover this loss. If they dont, this bank may also fail leading to financial industry collapse.
What are some of the tools available to financial market regulators to avoid bank failure?
1) Cash Ratio. This is where it forces banks to increase or hold cash assets so it meets its short term liabilities. Reducing bank run.
2) Liquidity ratio. This is the same as cash ratio but it involves all short term assets. Reducing bank run.
3) Leverage ratio. Ensures theres enough capital to offset any loses in advances or long term investment which reduces insolvency risk.
3) Reserve requirements. When moneys deposited into a bank, the bank must put a certain % in the BOE. This amount can be increased by regulators to prevent bank failure.
