Posted by Yi-Xin Jin (Lily)
The factor that is most concerned by the central banks is the provision of short-term liquidity. Short-term liquidity reduces interest rates but encourages more risky-behavior and investments. When interest rates are low because investors’ perception of risk is ‘underpriced’ then that would just lead to another financial crisis in which people have invested too much money. When investors overlook the cost of the risks, the banks are automatically affected by the credit crunch. As one bank defaults, the ‘contagion’ spreads to other banks, which calls for the central banks to lend money to lift them out the predicament. Central banks take on the “lender of last resort” role because this information is publicly known by the customers of those borrowing banks, causing customer to lose confidence in their own banks. Customers start to lose confidence in their own banks when central banks start intervening. However, central banks guarantee to lend “against good collateral at a penalty rate (Bank of England, p.9)” so that banks could recover themselves from liquidity problems, but the penalty rate is higher than the market’s interest rate.
The other major “safety net” besides “lender of last resort” is the Federal Deposit Insurance Company (FDIC). The FDIC’s role is to “provide ‘insurance’ coverage for consumer bank deposits in case of a bank failure (The Augusta Chronicle).” It offers depositor insurance that is over the normal amount, so that depositors will not be afraid of losing all their money. The FDIC can also “make loans and nationalize banks (Professor Wilkinson).” Their responsibilities include insuring savings, checking, and money market accounts, as well as certificates of deposit (CDs) (The Augusta Chronicle). “For single accounts, a depositor's money is insured for up to $100,000… joint account at the bank, that account is insured for up to $200,000 (The Augusta Chronicle).” This safety net is evidence that regulation can provide consumer confidence which may lead to more deposits in banks and a lesser chance of banks defaulting and another financial crisis.
Sources:
1.http://www.bankofengland.co.uk/publications/other/treasurycommittee/other/paper070912.pdf
2. http://chronicle.augusta.com/stories/081108/yrb_469038.shtml
3. http://bankdeals.blogspot.com/2009_01_01_archive.html
The factor that is most concerned by the central banks is the provision of short-term liquidity. Short-term liquidity reduces interest rates but encourages more risky-behavior and investments. When interest rates are low because investors’ perception of risk is ‘underpriced’ then that would just lead to another financial crisis in which people have invested too much money. When investors overlook the cost of the risks, the banks are automatically affected by the credit crunch. As one bank defaults, the ‘contagion’ spreads to other banks, which calls for the central banks to lend money to lift them out the predicament. Central banks take on the “lender of last resort” role because this information is publicly known by the customers of those borrowing banks, causing customer to lose confidence in their own banks. Customers start to lose confidence in their own banks when central banks start intervening. However, central banks guarantee to lend “against good collateral at a penalty rate (Bank of England, p.9)” so that banks could recover themselves from liquidity problems, but the penalty rate is higher than the market’s interest rate.
The other major “safety net” besides “lender of last resort” is the Federal Deposit Insurance Company (FDIC). The FDIC’s role is to “provide ‘insurance’ coverage for consumer bank deposits in case of a bank failure (The Augusta Chronicle).” It offers depositor insurance that is over the normal amount, so that depositors will not be afraid of losing all their money. The FDIC can also “make loans and nationalize banks (Professor Wilkinson).” Their responsibilities include insuring savings, checking, and money market accounts, as well as certificates of deposit (CDs) (The Augusta Chronicle). “For single accounts, a depositor's money is insured for up to $100,000… joint account at the bank, that account is insured for up to $200,000 (The Augusta Chronicle).” This safety net is evidence that regulation can provide consumer confidence which may lead to more deposits in banks and a lesser chance of banks defaulting and another financial crisis.
Sources:
1.http://www.bankofengland.co.uk/publications/other/treasurycommittee/other/paper070912.pdf
2. http://chronicle.augusta.com/stories/081108/yrb_469038.shtml
3. http://bankdeals.blogspot.com/2009_01_01_archive.html
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