Ch19 - End of Chapter Question Ch 19 1 What is a contagious...

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1 End of Chapter Question Ch 19 1. What is a contagious run? What are some of the potentially serious adverse social welfare effects of a contagious run? Do all types of FIs face the same risk of contagious runs? A contagious run is an unjustified panic condition in which liability holders withdraw funds from a depository institution without first determining whether the institution is at risk. This action usually occurs at a time that a similar run is occurring at a different institution that is at risk. The contagious run may have an adverse effect on the level of savings that may affect wealth transfers, the supply of credit, and control of the money supply. Depository institutions and insurance companies face the most serious risk of contagious runs. 2. How does federal deposit insurance help mitigate the problem of bank runs. What other elements of the safety net are available to banks in the U.S.? Bank runs are costly to society since they create liquidity problems and can have a contagion effect. Because of the first-come, first-serve nature of deposit liabilities, bank depositors have incentives to run on the bank if they are concerned about the bank's solvency. As a result of the external cost of bank runs on the safety and soundness of the entire banking system, the Federal Reserve has put into place a safety net to remove the incentives to undertake bank runs. The primary pieces of this safety net are deposit insurance and other guaranty programs that provide assurance that funds are safe even in cases when the FI is in financial distress. Other elements of the federal safety net are access to the lender of last resort (discount window borrowing), reserve requirements, and minimum capital guidelines. 3. What is moral hazard? How did the fixed-rate deposit insurance program of the FDIC contribute to the moral hazard problem of the savings and loan industry? What other changes in the S&L environment during the 1980s encouraged the developing instability of the industry? Moral hazard occurs in the financial institution industry when the provision of deposit
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This note was uploaded on 02/22/2009 for the course ECONOMICS 4313 taught by Professor Tsui during the Spring '09 term at HKU.

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Ch19 - End of Chapter Question Ch 19 1 What is a contagious...

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