Question

a) ABC Bank is facing a financial crisis due to the simultaneous run of customers to the bank to convert their deposits in cash. With this situation, explain in your own words the reasons that drove the depositors to act in such a way. Assume you’re a top manager at the bank; explain what are the options that the management has that will save them from being insolvent due to the massive withdrawals.

b) Financial institutions in Bahrain are highly regulated and monitored by the Central bank of bahrain. In your own words, explain how the Central bank of bahrain applies regulatory and monitoring authority in order to manage the financial institutions in the Kingdom. For your answer, refer to the current situation that is taking place; explain how does and will the Central bank of bahrain help protect the economy of the Kingdom.

c) There are many situations that may contribute to the inflation of an economy where the volatility and uncertainty can lead to lower levels of investments. With regards to the current situation (COVID-19) that is taking place around the world, many stores and businesses in the Kingdom of Bahrain and around the world were faced to close their doors to customers for at least two weeks. Explain in your own words, how these businesses and financial institutions will make up for the losses they are or may face. Will these businesses and financial institutions cause inflation within the economy? Explain.

d)Monopoly is a market structure characterized by a single seller, selling a unique product in the market. In a monopoly market, the seller faces no competition, as he is the sole seller of goods with no close substitute. Monopoly typically has an unfair advantage since they are either the only provider of a product or control most of the market share or customers for the product. Although monopolies might differ from industry-to-industry, they tend to share similar characteristics. Discuss at least three (3) of these characteristics in your own words.

e)Over the short term, the financial crisis of 2008 affected the banking sector by causing banks to lose money on mortgage defaults, interbank lending to freeze, and credit to consumers and businesses to dry up. For the much longer term, the financial crisis impacted banking by spawning new regulatory actions. Furthermore, some believe that commercial banks where more fragile during the crisis which made them at more risk of a bank run. In your opinion, discuss whether you agree or not and why.

Answer 1

(a) A bank run is most commonly caused by the fear that the institution is, or might become, insolvent. A bank run occurs due to depositors' panic rather than actual insolvency on the part of the bank. A bank run that emanates from public fear and that pushes a bank into actual bankruptcy is an example of a self-fulfilling prophecy. As more people withdraw money, the risk of bankruptcy increases and this triggers even more withdrawals. The bank risks default, as individuals keeping withdrawing funds. So what begins as panic can eventually turn into a true default situation.

There are a few steps that the management can take to deal with this situation:

1. Withdrawal Limits - The bank may limit the number of withdrawals per customer or suspend all withdrawals altogether as a way of dealing with the panic.

2. Borrow - The bank may get more cash from other banks or from the central bank to increase its cash on hand.

3. Insure deposits - When people know their deposits are insured by the government, their fear generally subsides. This has been the case since the U.S. established the FDIC.

4. Management Assurances - Public statements and appeals by the management assuring customers of the safety of their deposits to build trust into the banking institution.

(b) 1. Deferment of Installments - CBB ordered banks, financing, and microfinance companies to offer six-month deferrals on installments for borrowers impacted by the coronavirus outbreak without fees or interest.

2. Slashing of key interest rates - Bahrain’s central bank also cut its key interest rates multiple times to inject liquidity in the system. The Central Bank of Bahrain cut its interest rates on overnight, one-week and one-month deposits by 75 bps to 0.75%, 1.00% and 1.45% respectively. It cut its lending rate by the same level to 1.7% from 2.45%.

3. Reduction of Cash Reserve Ratio (CRR) - CBB also reduced the cash reserve ratio for retail banks to 3% from 5% in order to promote lending by the banks.

(d) Three common characteristics of monopolies across industries are:

1. High Entry Barriers - The entry of a new firm into the industry is effectively barred by legal or natural barriers. For eg. In Saudi Arabia, Saudi Aramco has a monopoly on the nation's oil reserves and holds exclusive drilling rights.

2. Price maker - The monopoly decides the price of the good or product being sold. The price is set by determining the quantity in order to demand the price desired by the firm (maximizes revenue). An example is the pricing mechanism followed by the OPEC cartel to decide global oil prices.

3. No substitute goods - A monopoly sells a good for which there is no close substitute. The absence of substitutes makes the demand for that good relatively inelastic, enabling monopolies to extract positive profits.

(e) The financial crisis that began in 2008 decimated the banking sector. A number of banks went under, others had to be bailed out by governments and still others were forced into mergers with stronger partners.

Before the financial crisis hit in 2008, regulations passed in the U.S. had pressured the banking industry to allow more consumers to buy homes. Starting in 2004, US Mortgage loan companies like Fannie Mae and Freddie Mac purchased huge numbers of mortgage assets including risky Alt-A mortgages. They charged large fees and received high margins from these subprime mortgages, also using the mortgages as collateral for obtaining private-label mortgage-based securities. Many foreign banks bought collateralized U.S. debt as subprime mortgage loans were rebundled into collateralized debt obligations and sold to financial institutions around the world.

When increasing numbers of U.S. consumers defaulted on their mortgage loans, U.S. banks lost money on the loans, and so did banks in other countries. Banks stopped lending to each other, and it became tougher for consumers and businesses to get credit.

With the U.S. falling into a recession, the demand for imported goods plummeted, helping to spur a global recession. Confidence in the economy took a nosedive and so did share prices on stock exchanges worldwide.

In hopes of averting another financial crisis, in December of 2009, the international Basel Committee introduced a set of proposals for new capital and liquidity standards for the global banking sector. The reforms, known as Basel III, were passed by the G-20 in November 2010. US legislature also created the Financial Stability Oversight Council, to include the Federal Reserve Bank and other agencies for the purpose of coordinating the regulation of larger, "systemically important" banks. The council can break up large banks that might present risk because of their sizes. A new Orderly Liquidation Fund was established to provide financial assistance for the liquidation of big financial institutions that fall into trouble.