Question 1

The regulatory practice of excessive capital forbearance is a method of reducing the short-run and long-run costs to deposit insurance funds.

Accepted Answer

The regulatory practice of excessive capital forbearance is actually a method of increasing the short-run costs to deposit insurance funds because it allows banks to continue operating with inadequate capital, which increases the likelihood of a failure and the subsequent costs to the deposit insurance fund.

Question 2

The improved financial health of the FDIC during the 1990s resulted in a considerable reduction in deposit insurance premiums.

Accepted Answer

The improved financial health of the FDIC during the 1990s allowed for a reduction in deposit insurance premiums.

Question 3

Because deposit insurance premiums were not priced in an actuarially fair manner during the period from 1933-1980s, instability was created in the credit and monetary system.

Accepted Answer

The answer of Because deposit insurance premiums were not priced...

Question 4

Currently in the U.S., deposit insurance premiums increase with the amount of risk of the institution.

Accepted Answer

Deposit insurance premiums are based on risk-based premiums, where institutions with higher risk pay higher premiums. This incentivizes banks to maintain a strong and safe financial position.

Question 5

The prompt corrective action program of the FDIC Improvement Act allows a bank or thrift to be placed into receivership when the book value of capital to assets falls below 2 percent.

Accepted Answer

The FDIC Improvement Act requires a bank or thrift to be placed into receivership when the book value of capital to assets falls below 2 percent as part of its prompt corrective action program.

Question 6

The ability of the FDIC to place a bank into receivership even though the book value of capital remains positive is an attempt to institute increased stockholder discipline.

Accepted Answer

The FDIC's ability to place a bank into receivership even if the book value of capital remains positive is intended to promote increased shareholder discipline by making it clear that if shareholder discipline is not upheld, the bank may still fail and investors may lose their money.

Question 7

The use of the option pricing model to determine the actuarially fair premium is difficult to apply in practice because the asset values and risks are difficult to determine.

Accepted Answer

The statement is true. The option pricing model requires accurate estimates of asset values and risks, which can be difficult to determine in practice, leading to challenges in applying the model to determine actuarially fair premiums.

Question 8

The cost of insolvency of an FI to the FDIC is offset in part by the deposit insurance premiums paid by the bank.

Accepted Answer

The FDIC collects deposit insurance premiums from insured banks, which are used to fund the deposit insurance system and cover the costs of resolving failed banks. Therefore, the cost of insolvency of an FI is offset in part by the deposit insurance premiums paid by the bank.

Question 9

Requiring higher capital ratios often is proposed as method to reduce the incentive to take excessive risk because the moral-hazard risk-taking incentives are thought to decrease as the amount of net worth increases.

Accepted Answer

Requiring higher capital ratios increases a bank's net worth, which reduces the likelihood of insolvency and decreases the moral-hazard risk-taking incentives. Therefore, it is true that higher capital ratios can reduce incentives to take excessive risk.

Question 10

Risk-based capital supports risk-based deposit insurance premiums by increasing the cost risk taking for DI stockholders.

Accepted Answer

Risk-based capital requires DI stockholders to hold higher capital levels for riskier assets, which in turn increases the cost of risk-taking. This supports risk-based deposit insurance premiums that charge higher premiums for DI's with higher levels of risk.

Question 11

The use of the option pricing model to determine the actuarially fair premium for deposit insurance indicates that the cost of the insurance should rely on both the asset size and level of leverage of the DI.

Accepted Answer

The answer of The use of the option pricing model...

Question 12

The initial risk-based deposit insurance program implemented on January 1, 1993 was based on capital adequacy and supervisory judgments involving asset quality, loan underwriting standards and other operating risks.

Accepted Answer

The statement is true. The initial risk-based deposit insurance program implemented on January 1, 1993 was indeed based on capital adequacy and supervisory judgments involving asset quality, loan underwriting standards and other operating risks.

Question 13

The Designated Reserve Ratio is a rule that stipulates that highly-rated DIs would not pay deposit insurance premiums if this ratio was above 0.25 percent.

Accepted Answer

The Designated Reserve Ratio (DRR) is a target set by the FDIC for the Deposit Insurance Fund (DIF), not a rule about premium payments by highly-rated depository institutions (DIs) based on the ratio being above 0.25 percent. Premiums are determined by a variety of factors, not just the DRR.

Question 14

The use of subordinated debt as a replacement for common stock has been proposed as a method of increasing stockholder discipline.

Accepted Answer

The answer of The use of subordinated debt as a...

Question 15

Pricing deposit insurance premiums to reflect increases in risk-taking by financial institutions is one method to reduce incentives to take risks.

Accepted Answer

Pricing deposit insurance premiums to reflect increases in risk-taking by financial institutions can make them pay for the cost of their risky behavior, reducing their incentives to take such risks.

Question 16

The policy of capital forbearance practiced by the FSLIC in the late 1980s allowed many commercial banks to remain open even in the face of continuing losses and insolvency.

Accepted Answer

The policy of capital forbearance was practiced by the Federal Savings and Loan Insurance Corporation (FSLIC) primarily on savings and loan institutions (S&Ls), not commercial banks, allowing them to remain open despite insolvency.

Question 17

The provision of deposit insurance is similar to the FDIC selling a call option on the assets of a bank allowing the FDIC to exercise the option and seize the bank's assets if the bank becomes insolvent.

Accepted Answer

Deposit insurance, provided by the FDIC, is more akin to the FDIC offering protection to depositors against the loss of their deposits if a bank fails, rather than the FDIC having an option to seize a bank's assets. The primary purpose is to maintain public confidence in the banking system, not to give the FDIC an option to acquire assets.

Question 18

The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) required the FDIC to establish risk-based premiums for deposit insurance coverage at banks.

Accepted Answer

The answer of The Financial Institutions Reform, Recovery, and Enforcement...

Question 19

More than 90 percent of all insured DIs did not pay deposit insurance premiums in the late 1990s and early 2000s.

Accepted Answer

This statement is true. During this time period, the Deposit Insurance Fund had a surplus and did not require insured DIs to pay premiums.

Question 20

One of the overall objectives in using subordinated debt in addition to common stock for a DI's capital base is to improve market discipline of a DI's risk structure.

Accepted Answer

Subordinated debt holders have a greater incentive to monitor and discipline the DI's risk-taking behavior, as their claims in case of insolvency come after those of depositors and other creditors. This can lead to improved market discipline of the DI's risk structure.

Quiz 20: Deposit Insurance and Other Liability Guarantees