Question

What are the principal uses of funds (assets) and sources of funds (liabilities) of banks? Explain each. What are the two potential problems inherent in our banking system? Explain each. What is a bank run? Explain. How can a bank run turn into a financial panic? Explain. How can the Federal Reserve prevent banking panics? Explain. How can a bank become insolvent? Explain. How can policy makers deal with banks/financial institutions that become insolvent? Explain.

Answer 1

Answer:

Principal use of funds of bank is for giving loans to businesses and to households. Principle sources of funds of banks are the deposits by the public. Potential problems inherent in banking system are of low interest rate and high competition. Because of low interest rate and high competition banks need to provide more services at lower profits. Bank run is a situation when many depositors withdraw their money at the same time. This situation turns into financial panic when due to withdrawal made by some people other people think that the banks financial condition is not good and depositors should withdraw their money from the bank immediately. Federal reserve can prevent banking panics by providing short term loans to the banks so that they can meet the immediate demand for cash withdrawals from the bank and Fed can also assure the depositors about the financial condition of the bank.

A bank can become insolvent when it fails to repay its debt(liabilities) and also finds it impossible to pay in future. Policy makers can deal with the insolvent financial institutions and banks in many ways. They can be merged with other banks, they can be taken over by the other banks. They can be provided by a financial relief package by the Policy makers. This will give these banks a new term to operate and to improve on their financial condition.