Question

Suppose that the mortgage default rate turns out to be higher than the bank expected.

How does this fact affect a bank's net worth?

A) It reduces it because the bank must write off the value of the loan.

B) It reduces it because the bank now has lower liabilities.

C) It increases net worth because the bank earns a higher interest rate on riskier

mortgages.

D) It has no impact.

_____ grew as a share of bank lending from around 26 percent in 1973 to around 59

percent in 2009.

A) Real estate loans

B) Commercial loans

C) Consumer loans

D) Industrial loans

Bank runs are created when:

A) the Fed declares a bank insolvent.

B) depositors lose confidence in a bank.

C) a bank's reserves fall to zero.

D) interest rates are very low.

A bank run is an extreme form of:

A) credit risk.

B) interest rate risk.

C) low bank esteem.

D) liquidity risk.

Answer 1

1. A) It reduces it because the bank must write off the value of the loan.

If mortgage default rate turns out to be higher than the bank expected, the banks have to write off the value of these loans as NPA (non performing assets). This adversely affects the profitability of the bank as well as it net worth.

2. A) Real estate loans

Real estate loans increased exponentially as a share of bank loans till 2009 which resulted in boom in the housing market.

3. B) depositors lose confidence in a bank.

A bank run occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future.  As more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits.

4. D) liquidity risk.

During a bank run, as more customers withdraw their money, there is a likelihood of default, and this will trigger more withdrawals to a point where the bank runs out of cash. An uncontrolled bank run can lead to bankruptcy. Thus the basis of bank runs is liquidity risk.