topic 12 - deposit insurance & other liability guarantees

Question 1

what are the causes of depositary fund insolvency?

Answer 1

1. financial environment (external shock/events)
2. moral hazard

Question 2

what is moral hazard?

Answer 2

loss of exposure faced by an insurer when the provision of insurance encourages the insured to take more risks

Question 3

how can deposit insurance be structured so that moral hazard is reduced?

Answer 3

1. increase stockholder discipline (link insurance premiums to risk profile of DI = actuarially fairly priced insurance)
2. increase depositor discipline (higher interest rates/ratio amount of deposits held in riskier DIs)
3. increase regulator discipline (frequency & thoroughness of examinations)

Question 4

what is capital forbearance?

Answer 4

regulators’ policy of allowing a FI to continue operating even when its capital funds are fully depleted

Question 5

what is the prompt corrective action program?

Answer 5

mandatory actions that have to be taken by regulators as a DI’s capital ratio falls

Question 6

how can stockholder discipline be increased?

Answer 6

1. increase capital requirements & imposed stricter DI closure rule to control capital forbearance
2. prompt corrective action program