M20_MISH1438_06_IM_C20 - Chapter 20 Banking Regulation...

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Chapter 20 Banking Regulation Asymmetric Information and Bank Regulation Government Safety Net: Deposit Insurance and the FDIC Global Box: The Spread of Government Insurance Throughout the World: Is This a Good Thing? Restrictions on Asset Holdings and Bank Capital Requirements Mini-Case Box: Basel 2: Is it Unworkable? Bank Supervision: Chartering and Examination Assessment of Risk Management Disclosure Requirements Consumer Protection Restrictions on Competition E-Finance Box: Electronic Banking: New Challenges for Bank Regulation International Banking Regulation Problems in Regulating International Banking Summary The 1980s U.S. Banking Crisis Federal Deposit Insurance Corporation Improvement Act of 1991 Banking Crises Throughout the World Scandanavia
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113 Mishkin/Eakins • Financial Markets and Institutions, Sixth Edition Latin America Russia and Eastern Europe Japan China East Asia Deja Vu All Over Again Overview and Teaching Tips This chapter stresses an analytic way of thinking by conducting an analysis using the adverse selection and moral hazard concepts to show why our regulatory system takes the form it does and how it led to a banking crisis. The chapter has an appendix available on the website which provides a case in which the student is asked to evaluate the FDICIA legislation to see if it will achieve its goals. Covering this case in class is an excellent way of getting the students to review the material in the chapter. Note that Chapter 15 does not need to be covered in order to teach this chapter. However, if Chapter 15 is covered in class, Chapter 20 is a nice application of the analysis in that chapter. Indeed, the instructor might want to stress in class the counterparts in private financial markets to the methods bank regulators use to cope with adverse selection and moral hazard. Answers to End-of-Chapter Questions 1. There would be adverse selection because people who might want to burn their property for some personal gain would actively try to obtain substantial fire insurance policies. Moral hazard could also be a problem because a person with a fire insurance policy has less incentive to take measures to prevent a fire. 2. Chartering banks is the bank regulation that helps reduce the adverse selection problem because it attempts to screen proposals for new banks to prevent risk-prone entrepreneurs and crooks from controlling them. It will not always work because risk-prone entrepreneurs and crooks have incentives to hide their true nature and thus may slip through the chartering process. 3. Regulations that restrict banks from holding risky assets directly decrease the moral hazard of risk taking by the bank. Requirements that force banks to have a large amount of capital also decrease the banks’ incentives for risk taking because banks now have more to lose if they fail. Such regulations will not completely eliminate the moral hazard problem because bankers have incentives to hide their holdings or risky assets from the regulators and to overstate the amount of their capital. 4.
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M20_MISH1438_06_IM_C20 - Chapter 20 Banking Regulation...

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