Introduction

Question 1

What are the main economic roles of retail and commercial banks ?

Answer 1

• Offer loans to the real sector

* Provide liquidity and payment services to depositors

Question 2

Why do banks exist ? (2)

Answer 2

• Convenience of denomination

* Frictions due to asymmetric information

Question 3

What is the convenience of denomination ?

Answer 3

Depositors are small, while borrowers tend to be large
⇒ Banks offer deposits and loans in convenient unit sizes
⇒ Important in practice but not so interesting

Question 4

What are the frictions due to asymmetric information ?

Answer 4

Some agents have private information. E.g. borrowers know more about their projects than lenders
⇒ Incomplete financial markets
⇒ Adverse selection (ex-ante) and moral hazard (ex-post)
⇒ Financial intermediaries mitigate some of these frictions

Question 5

What do banks perform to mitigate the frictions due to asymmetric information ?

Answer 5

They perform maturity transformation and monitor their borrowers.

Question 6

Why do banks take deposits with short maturities ?

Answer 6

Deposits are easy to value and hence liquid.

Question 7

Why do banks offer loans with long maturities ?

Answer 7

⇒ Asymmetricity of information make loans are hard to value for outsiders and thus illiquid
⇒ Value of a bank loan may depend on the monitoring performed by the bank

Question 8

What are the flip sides of maturity transformation and monitoring ?

Answer 8

• Maturity transformation exposes banks to liquidity risk
⇒ Banks are inherently unstable and prone to liquidity crises

• Asymmetric information and the need to monitor the
borrowers render bank loans hard to value for outsiders
⇒ Bank assets are opaque
⇒ If a bank experiences a liquidity crisis or even fails, liquidating the bank’s assets may be very costly
⇒ Bank failures have huge economic costs

Question 9

Why do banking crises have large external costs ?

Answer 9

• Risk of financial contagion

* Refinancing problems in the real sector

Question 10

What do the government do to avoid the costs of a banking crisis that may be too big to be politically acceptable ?

Answer 10

Government safety nets like deposit insurance, lending of last resort, and bailouts

Question 11

What does it mean when a bank is “too big to fail” ?

Answer 11

Large banks enjoy implicit government

guarantees as they are deemed too important to let them fail

Question 12

What kind of frictions may government safety nets have ?

Answer 12

For instance moral hazard, i.e. incentives for the banks to take excessive risks at the publics’ expense

Question 13

Why are the questions of why and how to regulate banks especially relevant for Switzerland ?

Answer 13

The Swiss banking sector is :
• Highly concentrated
• Of great macroeconomic importance