BEEM119
UNIVERSITY OF EXETER BUSINESS SCHOOL
May 2019
Economics of Banking Module Convenor: Dr Pradeep Kumar
Duration: TWO HOURS
Answer ALL SIX questions from Section A and ONLY FOUR questions from Section B. If you answer ALL FIVE questions in section B, only the first FOUR will be marked.
All questions in Section A are worth 8 marks each. All questions in Section B are worth 13 marks each. Approved calculators are permitted.
This is a closed note paper.
If some question is not clear to you, state your assumption and provide an answer under that assumption.
SECTION A
(Answer all questions)
1. What measures can a lender take to reduce asymmetric information in direct finance such as bonds?
2. Why does deposit insurance worsen the moral hazard problem in the banking industry? How do regulators mitigate this issue?
3. As a monetary policy tool, why is it desirable to target interest rates rather than money supply for a central bank?
4. ABC Bank¡¯s balance sheet is the following:
Assets
Liabilities & Net Worth
Reserves
10
Current Deposits
40
T-bills
40
Savings Deposits
60
Loans
80
Net Worth
30
Total
$130
Total
$130
ABC Bank sells $10 worth of loans for $10 of cash.
(a) How does the new balance sheet look after this sale?
(b) Suggest two possible reasons behind this sale. What is the ABC Bank expected to do next?
5. Why accounting for risk is important in the measurement of cost efficiencies in the banking industry? Does ignoring risk leads to over-estimation or under-estimation of cost efficiencies? Explain.
6. What are the policy implications of the Efficient Structure Hypothesis (ESH) and Relative Market Power Hypothesis (RMPH) for a highly concentrated banking industry? Discuss.
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Turn over
SECTION B
(Answer only four questions)
7. Explain the regression model used to derive the H-statistic of the Panzar-Rosse methodology. What is a necessary condition for the Panzar-Rosse methodology and how can we test it?
8. Using the loanable funds theory, show in a graph how each of the following events affect the supply and demand for loans and the equilibrium real interest rate:
(a) UK residents hold additional idle cash due to uncertainty in the Brexit terms and conditions.
(b) In addition to (a), EU residents also hold additional idle cash.
9. Derive an expression for the equilibrium loan rate in a monopoly (Monty-Klein) model of banking. Alongside deposits and loans, assume that there is also a market for treasury bills. Assume that the operating cost of servicing depends on volume of deposits and loans, C(D,L). Also, assume that banks are setting volume of deposits and loans instead of interest rates. Clearly state any other assumptions you make for the derivation. What is the main criticism of this theoretical model?
10. Describe how the Data Envelopment Analysis (DEA) method is used to estimate cost efficiencies of banks. What is one of the major drawbacks of the DEA method?
11. Suppose the Bank of England (Central Bank) reduces short-term interest rates on government bonds to increase the aggregate output in the economy. Describe the various effects on the profits of commercial banks with respect to interest-rate risk, credit risk and economic risk.
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End of Paper