Chapter 14: Regulating the Financial System

Vocabulary practice flashcards covering Chapter 14: Regulating the Financial System, focusing on bank runs, government safety nets, supervisory tools, and prudential regulatory frameworks.

Bank Run

A rush by depositors to withdraw their funds simultaneously from a bank, driven by fear of insolvency and the bank's first-come, first-served withdrawal policy.

Solvency

The financial state in which the value of a bank's assets exceeds the value of its liabilities, indicating positive net worth.

Liquidity (Bank)

A bank's capacity to satisfy depositors' demands for immediate withdrawal by maintaining sufficient cash reserves and immediately marketable assets.

Contagion

The transmission of panic from a single failing bank across the broader financial system, primarily fueled by information asymmetries that prevent depositors from distinguishing sound banks from weak ones.

Breaking the Buck

A condition in which a money-market mutual fund (MMMF) drops its net asset value below the promised standard value of $\$1$ per share.

Lender of Last Resort

A central bank function, originally suggested by Walter Bagehot in 1873, that supplies emergency liquidity and collateralized loans to solvent institutions facing severe deposit outflows to halt panics.

Securities Investor Protection Corporation (SIPC)

An agency that protects investors against fraud or the failure of a brokerage firm by replacing missing securities or cash up to $\$500{,}000$, without protecting against poor investment decisions.

Payoff Method

An FDIC bank resolution procedure in which the regulatory authority shuts down the failing institution, pays off all insured depositors up to the legal ceiling, and sells the remaining assets.

Purchase-and-Assumption Method

The most common resolution mechanism used by the FDIC, in which a viable financial institution is found to take over the assets and liabilities of a failed bank seamlessly without depositor losses.

Systemically Important Financial Institution (SIFI)

A formal legal designation established by the Dodd-Frank Act for financial intermediaries that are too large or too interconnected to fail or resolve without generating harmful systemic spillovers.

Time Consistency Problem

The policy credibility dilemma occurring when governments promise during good times not to bail out institutions, but retain strong incentives to rescue them once a crisis occurs, thereby inducing moral hazard.

Call Reports

Standardized periodic financial reports that all chartered depository institutions are mandated to submit to regulatory agencies every quarter.

CAMELS Criteria

A confidential rating framework utilized by bank supervisors to evaluate Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk.

Stress Tests

Forward-looking regulatory assessments mandated by the Dodd-Frank Act for SIFIs to evaluate whether financial institutions possess sufficient capital to withstand simulated severe economic downturns.

1988 Basel Accord (Basel I)

An international regulatory agreement requiring internationally active banks to hold capital equal to or greater than $8\%$ of their risk-adjusted assets.

Basel III

A comprehensive 2010 regulatory framework that introduced leverage caps, high-quality liquid asset requirements, and three additional capital buffers: the capital conservation buffer, countercyclical capital buffer, and systemic capital surcharge.

Narrow Bank

A proposed banking structure where traditional deposit-taking institutions are restricted to holding strictly riskless, liquid assets like $100\%$ reserves, reallocating lending activities to mutual funds.

Micro-Prudential Regulation

Oversight centered on limiting risk exposure within individual financial institutions to minimize the failure probability of any specific firm.

Macro-Prudential Regulation

Regulatory policy that manages systemic risk across the financial system as a collective negative externality, countering widespread risks like common exposure and pro-cyclicality.

Pro-Cyclicality

The mutually reinforcing feedback loop between financial and economic activity that amplifies unsustainable boom-and-bust cycles.

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

Major U.S. legislation aimed at strengthening the financial system, mitigating crises via systemic risk oversight, ending 'too big to fail,' and reducing moral hazard.