Financial regulation: Practice Questions

• a.

  To limit the total amount of money a bank can lend to the government to finance the national debt.

• b.

  To ensure that banks have a sufficient buffer to absorb potential losses, thereby reducing the risk of insolvency.

• c.

  To increase the velocity of circulation in the economy by forcing banks to move capital into liquid savings accounts.

• d.

  To ensure that the interest rates charged on mortgage products are kept at a level affordable for first-time buyers.

• a.

  It prevents the central bank from using open market operations to influence the base interest rate due to asymmetric information.

• b.

  The expectation of a central bank rescue may encourage commercial banks to take excessive risks, knowing they are 'too big to fail'.

• c.

  It leads to a reduction in the capital adequacy ratio because banks are unable to accurately calculate their risk-weighted assets.

• d.

  It forces the central bank to decrease the money supply, which leads to a deflationary spiral and increased real debt burdens.

• a.

  Acting as the primary source of credit for small and medium-sized enterprises when commercial banks increase interest rates.

• b.

  Providing liquidity to solvent financial institutions facing temporary cash flow shortages to prevent systemic collapse.

• c.

  Offering low-interest loans to the general public during a period of high unemployment and low consumer confidence.

• d.

  Bailing out insolvent commercial banks using taxpayer funds to ensure shareholders do not lose their investments.

• a.

  The FPC manages the liquidity of the central bank during financial crises, whereas the PRA focuses on international trade settlements and exchange rate stability.

• b.

  The FPC focuses on the day-to-day conduct and consumer protection within financial markets, while the PRA is solely responsible for setting the base interest rate.

• c.

  The FPC is responsible for macroprudential regulation to mitigate systemic risks to the whole economy, whereas the PRA focuses on the microprudential stability of individual firms.

• d.

  The PRA uses stress tests to ensure the banking system as a whole can withstand shocks, while the FPC is the primary body responsible for ensuring individual firms do not fail.

• a.

  It forces the government to run a budget surplus, which reduces the total level of aggregate demand in the economy.

• b.

  It may increase the costs of compliance for banks, leading to a reduction in the supply of credit available for investment.

• c.

  It automatically leads to an increase in the velocity of circulation, which causes hyperinflation and reduces real GDP.

• d.

  It prevents the central bank from acting as a lender of last resort, which increases the likelihood of a currency devaluation.

Write your answer out first, then check it against the worked solution.

Write your answer out first, then check it against the worked solution.

Write your answer out first, then check it against the worked solution.