19 - Chapter Nineteen Deposit Insurance and Other Liability...

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Chapter Nineteen Deposit Insurance and Other Liability Guarantees Chapter Outline Introduction Bank and Thrift Guaranty Funds The FDIC The Causes of the Depository Fund Insolvencies The Financial Environment Moral Hazard Panic Prevention versus Moral Hazard Controlling Depository Institution Risk Taking Stockholder Discipline Depositor Discipline Regulatory Discipline Non-U.S. Deposit Insurance Systems The Discount Window Deposit Insurance versus the Discount Window The Discount Window Other Guaranty Programs National Credit Union Administration Property-Casualty and Life Insurance Companies The Securities Investor Protection Corporation The Pension Benefit Guaranty Corporation Summary 223
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Solutions for End-of-Chapter Questions and Problems: Chapter Nineteen 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 major changes did the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 make to the FDIC and the FSLIC? The FIRREA ACT of 1989 closed down the FSLIC, the agency that used to provide deposit insurance to savings and loan associations (S&Ls). The responsibility of providing insurance to the S&Ls was transferred to the FDIC, which manages it through a separate program, the Savings and Insurance Fund. 4.
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This note was uploaded on 10/25/2010 for the course FIN 398 taught by Professor Ray,jackson during the Spring '10 term at UMass Dartmouth.

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19 - Chapter Nineteen Deposit Insurance and Other Liability...

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