FDIC Improvement Act of 1991

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Questions and Answers

What was the major criticism faced by the FDIC during the 1980s and 1990s?

The FDIC was criticized for its fixed-fee system, which led to a moral hazard problem.

What was the main objective of the FDIC Improvement Act of 1991?

To permit the FDIC to borrow from the Treasury to remain solvent and to define actions to be taken when depository institutions do not meet capital requirements.

What was the significance of the Consumer Credit Protection Act (also known as Truth in Lending)?

It required lenders to clearly spell out the customer's rights and responsibilities under a loan agreement.

What was the main goal of the Dodd-Frank Regulatory Reform bill?

To provide consumers with more complete and understandable language to convey service prices and avoid misleading information. Signup and view all the answers

What was the primary objective of the Equal Credit Opportunity Act?

To prevent discrimination in lending based on age, sex, race, national origin, or religious affiliation. Signup and view all the answers

What was the purpose of the Community Reinvestment Act?

To prohibit U.S. banking institutions from denying credit to certain communities or neighborhoods. Signup and view all the answers

What was the issue with the FDIC's fixed insurance premium system prior to 1993?

It led to a moral hazard problem, as institutions with riskier balance sheets were not penalized. Signup and view all the answers

What was the significance of risk-based insurance premiums introduced by the FDIC Improvement Act of 1991?

They took into account the riskiness of an individual depository institution's balance sheet. Signup and view all the answers

What type of financial institutions are lightly regulated and have relatively new oversight?

Hedge Funds, Private Equity Funds, and Venture Capital Companies Signup and view all the answers

What is the primary job of a central bank, such as the Federal Reserve System?

Making sure the supply and cost of money and credit contribute to the nation's economic goals Signup and view all the answers

What is the purpose of the Dodd-Frank Act of 2010 in relation to hedge funds and private equity funds?

To call for greater separation between commercial banks and these riskier private investors Signup and view all the answers

What does the Federal Reserve System do with most of its earnings?

Passes them along to the U.S. Treasury Signup and view all the answers

Why is the regulation of hedge funds, private equity funds, and venture capital companies relatively invisible?

Because it is relatively new and they normally do not seek out many funds from small investors Signup and view all the answers

What is the main goal of the Federal Reserve System in controlling the growth of money and credit?

To ensure the economy grows at an adequate rate, unemployment is kept low, and inflation is held down Signup and view all the answers

Which organization has broad oversight of the information provided by hedge funds, private equity funds, and venture capital companies when they sell securities in the open market?

The Securities and Exchange Commission (SEC) in the United States Signup and view all the answers

Why is the Federal Reserve System free to pursue its goals?

Because it does not depend on the government for its funding Signup and view all the answers

What is the primary function of a central bank in an economy?

To conduct money and credit policy to promote sustainable growth and avoid severe inflation. Signup and view all the answers

What are the three main tools used by central banks to influence the behavior of legal reserves, interest rates, and currency values?

Open market operations, the discount rate on loans to qualified financial institutions, and legal reserve requirements on various bank liabilities. Signup and view all the answers

What is the primary objective of central banks in conducting monetary policy?

To promote sustainable growth in the economy and avoid severe inflation. Signup and view all the answers

What is the significance of open market operations in central banking?

Open market operations have become the principal tool of central bank monetary policy. Signup and view all the answers

What is the purpose of legal reserve requirements on bank liabilities?

To influence the behavior of legal reserves and affect the money supply. Signup and view all the answers

What is the discount rate on loans to qualified financial institutions used for?

To influence the behavior of interest rates and affect the cost of borrowing. Signup and view all the answers

How does the Federal Reserve's loan of reserves to depository institutions temporarily affect the supply of legal reserves?

The supply of legal reserves expands temporarily. Signup and view all the answers

What is the role of the Reserve bank's board of directors and the Federal Reserve Board in setting the discount rate?

The Reserve bank's board of directors sets the discount rate, and it must be approved by the Federal Reserve Board. Signup and view all the answers

What is the potential effect on depository institutions when they repay discount window loans?

They may be forced to curtail the growth of their deposits and loans. Signup and view all the answers

What is the source of short-term loans for depository institutions, according to many central banks?

The central banks themselves. Signup and view all the answers

What happens to the supply of legal reserves when the Fed loans reserves to depository institutions?

It expands temporarily. Signup and view all the answers

What is the purpose of the Federal Reserve's open market operations, as stated in the Federal Open Market Committee (FOMC) statement?

To set a target for the federal funds rate. Signup and view all the answers

What is the main purpose of the Open Market Policy Tool in central banking?

To achieve the Fed's monetary policy goals by targeting the federal funds rate, which spreads to other interest rates in the economy. Signup and view all the answers

What happens to interest rates when the central bank sells securities?

Interest rates tend to rise. Signup and view all the answers

What is the effect of central bank purchases of securities on the growth of deposits and loans?

The growth of deposits and loans tends to increase. Signup and view all the answers

What is the role of primary dealers in conducting Open Market Operations?

They meet the Fed's qualifications and trade securities with the Federal Reserve. Signup and view all the answers

Why is Open Market Operations considered the most important policy tool for central banks?

It can be used every day and its effects can be quickly reversed if a mistake is made or conditions change. Signup and view all the answers

What is the Federal Open Market Committee's (FOMC) target in setting monetary policy?

The federal funds rate attached to overnight loans of reserves between depository institutions. Signup and view all the answers

What is the effect of central bank sales of securities on the financial system?

The growth of deposits and loans tends to decrease. Signup and view all the answers

What is the purpose of the Federal Reserve's trading desk in Open Market Operations?

To conduct transactions with primary dealers to implement monetary policy. Signup and view all the answers

Study Notes

Major Banking Laws – Where and When the Rules Originated

The FDIC Improvement Act (1991):
- Permitted the FDIC to borrow from the Treasury to remain solvent
- Introduced risk-based insurance premiums
- Defined actions to be taken when depository institutions did not meet capital requirements
- Replaced the fixed-fee system, which led to a moral hazard problem
Social Responsibility Laws:
- Consumer Credit Protection Act (Truth in Lending):
  - Required lenders to spell out customer rights and responsibilities under loan agreements
- Dodd-Frank Regulatory Reform bill:
  - Emphasized providing consumers with complete and understandable language to convey service prices and avoid misleading information
- Equal Credit Opportunity Act:
  - Prohibited denial of loans based on age, sex, race, national origin, religious affiliation, or public welfare status
- Community Reinvestment Act:
  - Prohibits U.S. banks from refusing credit to communities or neighborhoods based on demographics

The Regulation of Nonbank Financial-Service Firms Competing with Banks

Hedge Funds, Private Equity Funds, and Venture Capital Companies:
- Lightly regulated financial institutions
- Overseen by the SEC in the United States
- May sell securities in the open market accessible to small investors
- Regulation is relatively new and often invisible due to the sector's relatively recent emergence
- The Dodd-Frank Act of 2010 aims to separate commercial banks from these riskier private investors

The Central Banking System: Its Impact on the Decisions and Policies of Financial Institutions

The Federal Reserve System (the Fed):
- The central bank of the United States
- Primary job is monetary policy
- Aims to ensure the economy grows at an adequate rate, unemployment is low, and inflation is held down
- Independent from the government for funding, passing most earnings to the U.S. Treasury
Central Banking:
- Conducts money and credit policy to promote sustainable growth and avoid inflation
- Uses tools to affect legal reserves, interest rates, and currency values
- Employs open market operations, discount rates, and legal reserve requirements on bank liabilities

Open Market Operations (OMO)

Buying and selling U.S. Treasury bills, bonds, and notes, and selected federal agency securities
Conducted between the Fed's trading desk and primary dealers who meet the Fed's qualifications
Considered the most important policy tool for many central banks due to its flexibility and reversibility

The Fed's Monetary Policy Tools

Open market operations (OMO):
- Buying securities increases deposits and loans, and lowers interest rates
- Selling securities decreases deposits and loans, and raises interest rates
Federal Open Market Committee (FOMC):
- Targets the federal funds rate to achieve monetary policy goals
- Affects interest rates in the economy
Discount rate:
- The Fed lends reserves to depository institutions, temporarily expanding legal reserves
- Influences the growth of deposits and loans
- Set by each Reserve bank's board of directors and approved by the Federal Reserve Board

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Description

This quiz covers the FDIC Improvement Act of 1991, a major banking law that permitted the FDIC to borrow from the Treasury, introduced risk-based insurance premiums, and defined actions for depository institutions not meeting capital requirements.