17. Financial Innovation and the Credit Crunch

1. The problem of moral hazard occurs because:

there is a risk of people making fraudulent claims on their insurance policy. the existence of an insurance policy can raise the probability of an insured against event occurring. there is the risk of an insurance company not paying out on a justified claim. there is an obligation on an insurance company to re-insure someone who makes a claim.

2. Which of the following is represents regulation designed to cover the different types of activities, products and geographical boundaries within which financial institutions can operate?

Prudential regulation Structural regulation Investor protection regulation None of the above

3. When banks are required buy the regulatory authorities to maintain reserves against potential losses then we are referring to their:

Liquidity requirements Licensing requirements Capital adequacy Exposure limits

4. A key difference between the First Banking Directive of 1977 and the Second Banking Directive of 1989 was the concept of:

Mutual recognition European level supervision Harmonization of banking standards in EU countries European level licensing of banks.

5. The Basel Accord of 1988 established which of the following capital requirements?

Tier 1 minimum 4% Tier 2 sufficient to make minimum 8% overall. Tier 1 minimum 4% Tier 2 minimum 4% with minimum 8% overall. Combined Tier 1 plus Tier 2 capital minimum of 8% total but no minimum for Tier 1 capital. Tier 1 a minimum of 8% with no compulsory Tier 2 capital.

6. A key difference between the Basel I and Basel II capital adequacy rules is:

Basel II requires banks to hold significantly higher capital reserves than Basel I. Basel II permits Banks to use Internal Ratings Based models to influence the amount of capital reserves they need to hold subject to regulatory approval. Basel II require all banks to in the USA to meet Basel I standards not just the largest USA banks. Basel II includes both Indian and Chinese banks whereas Basel I did not.

7. A key difference between the Basel II and Basel III Accords is:

Basel III requires banks to hold significantly lower capital reserves than Basel II. Basel III lowers the range of Risk Weighted Assets considered. Basel III introduces a liquidity ratio. Basel III requires banks considered to be SIFIs to have only the minimum level of Capital Adequacy.

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