《货币银行学》课程授课教案（英文讲义）Chapter 08 Financial Industry Structure

Chapter8Financial Industry StructureChapter 83FinancialIndustryStructureProblemsandSolutions1. For many years, you have been using your local small-town bank.One dayyou hear that the bank is about to be purchased by Bank of America.Fromyour vantage point as a retail bank customer, what are the costs and benefitsof such amerger?Answer: The benefits are that you will have access to a larger network of ATMs andyou will be able to use your bank for a larger scope of financial services.However,you will receive less personal service.Furthermore,the costs of the services you useare likely to fall for two reasons.Economies of scale mean that larger banks havelower per unit costs; and economics of scope mean that banks with a broader array ofservices have lower costs as well.But the larger bank could use its monopoly powerto raise costs, as well.2.Consider the impact of the merger in Question 1 from the point of view of asmall business owner.Is the purchase of your small community bank good orbad?Explain your answer.Answer: The small business owner had likely developed a relationship with thecommunity bank, allowing him to borrow funds more easily. Unless some care istaken, information asymmetries could worsen.He will have to reestablish himself as agood credit risk with Bank of America, but won't be able to receive the same level ofpersonal service he experienced with the community bank.3.Why have technological advances hindered the enforcement of legalrestrictions onbank branching?Answer: Most people don't go into a physical bank building to withdraw cash fromtheir accounts or make a deposit; instead they go to an ATM.ATMs do not qualifyas “branches" of a bank, so a bank can expand its customer base across a largergeographic area without violating branching regulations.The advent of the Internetand electronic banking has made the location of bank buildings even less relevant4.Banks have been losing their advantage over other financial intermediaries inattracting customers'funds.Why?Answer: Other financial firms now exist to provide individuals with services typicallyperformed by banks.Money market mutual funds offer customers access tofinancial instruments that pay a higher rate of interest than bank deposits, yet are stillInstructor'sManual t/aCecchetti:Money,Banking,andFinancial Markets

Chapter 8 Financial Industry Structure Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets Chapter 8 Financial Industry Structure Problems and Solutions 1. For many years, you have been using your local small-town bank. One day you hear that the bank is about to be purchased by Bank of America. From your vantage point as a retail bank customer, what are the costs and benefits of such a merger? Answer: The benefits are that you will have access to a larger network of ATMs and you will be able to use your bank for a larger scope of financial services. However, you will receive less personal service. Furthermore, the costs of the services you use are likely to fall for two reasons. Economies of scale mean that larger banks have lower per unit costs; and economics of scope mean that banks with a broader array of services have lower costs as well. But the larger bank could use its monopoly power to raise costs, as well. 2.Consider the impact of the merger in Question 1 from the point of view of a small business owner. Is the purchase of your small community bank good or bad? Explain your answer. Answer: The small business owner had likely developed a relationship with the community bank, allowing him to borrow funds more easily. Unless some care is taken, information asymmetries could worsen. He will have to reestablish himself as a good credit risk with Bank of America, but won’t be able to receive the same level of personal service he experienced with the community bank. 3. Why have technological advances hindered the enforcement of legal restrictions on bank branching? Answer: Most people don’t go into a physical bank building to withdraw cash from their accounts or make a deposit; instead they go to an ATM. ATMs do not qualify as “branches” of a bank, so a bank can expand its customer base across a larger geographic area without violating branching regulations. The advent of the Internet and electronic banking has made the location of bank buildings even less relevant. 4. Banks have been losing their advantage over other financial intermediaries in attracting customers’ funds. Why? Answer: Other financial firms now exist to provide individuals with services typically performed by banks. Money market mutual funds offer customers access to financial instruments that pay a higher rate of interest than bank deposits, yet are still

Chapter 8 Financial Industry Structurevery liquid and can easily be converted into a means of payment.Banks no longerhave an advantage in screening loan applicants because of the ease with whichindividuals can transmit information, so a customer who needs a loan can go online toget price quotes instead of going to the local bank.Discount brokerage firmsprovide individuals with low-cost access to the financial markets.5. What has been the impact of the Internet on the structure of the bankingindustry?Answer: The Internet has rendered the physical location of a particular bank irrelevant.allowing large banks to expand across the country, and reducing the number of smalllocal banks.6.Describe the economies of scope that large financial holding companies hopeto realize.Do you believe they will be successful?Answer:Thecompanieshopetoreduce costsbyoffering customers a widerangeofservicesEnablingcustomerstocompletealloftheirfinancialactivitieswithoneinstitution should help to reduce costs, but the people who run the large companies areprobably more interested with increasing the size of their institutions.7.Discuss the problems life insurance companies will face as geneticinformationbecomes more widely available.Answer: Insurance companies can't predict when a particular person will die, butwhen they pool together a group of individuals with uncorrelated risks, they canpredict fairly accurately the outcome for the group as a whole.However, if thecompanieshaveaccesstogenetic information,theywillbeableto estimatewith someaccuracy when each individual is likely to die.Companies won't want to issueinsurance to individuals who will probably die soon, and individuals who are likely toremain healthy won't want to buy insurance.If the information were able tocompletelyeliminatetheuncertaintyaboutwhensomeonewilldie,thenthereisnolonger anything left to insure.8. How can the favorable tax treatment of pension funds encourage saving?Answer: When people can reduce their taxes by contributing some of their income toa pension fund, they are more likely to do so.These individuals will save moremoneyfortheirretirement.9. Why would property and casualty insurers have balance sheets that differfrom those of life insurance companies?Instructor'sManual t/aCecchetti:Money,Banking,andFinancial Markets

Chapter 8 Financial Industry Structure Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets very liquid and can easily be converted into a means of payment. Banks no longer have an advantage in screening loan applicants because of the ease with which individuals can transmit information, so a customer who needs a loan can go online to get price quotes instead of going to the local bank. Discount brokerage firms provide individuals with low-cost access to the financial markets. 5. What has been the impact of the Internet on the structure of the banking industry? Answer: The Internet has rendered the physical location of a particular bank irrelevant, allowing large banks to expand across the country, and reducing the number of small local banks. 6. Describe the economies of scope that large financial holding companies hope to realize. Do you believe they will be successful? Answer: The companies hope to reduce costs by offering customers a wide range of services. Enabling customers to complete all of their financial activities with one institution should help to reduce costs, but the people who run the large companies are probably more interested with increasing the size of their institutions. 7. Discuss the problems life insurance companies will face as genetic information becomes more widely available. Answer: Insurance companies can’t predict when a particular person will die, but when they pool together a group of individuals with uncorrelated risks, they can predict fairly accurately the outcome for the group as a whole. However, if the companies have access to genetic information, they will be able to estimate with some accuracy when each individual is likely to die. Companies won’t want to issue insurance to individuals who will probably die soon, and individuals who are likely to remain healthy won’t want to buy insurance. If the information were able to completely eliminate the uncertainty about when someone will die, then there is no longer anything left to insure. 8. How can the favorable tax treatment of pension funds encourage saving? Answer: When people can reduce their taxes by contributing some of their income to a pension fund, they are more likely to do so. These individuals will save more money for their retirement. 9. Why would property and casualty insurers have balance sheets that differ from those of life insurance companies?

Chapter8Financial Industry StructureAnswer: Property and casualty insurance companies have a different time horizonfromlifeinsurancecompanies.Property and casualty insurancecompanies oftenhave to make a large number of payments in the near future, so their assets areprimarily short-term securities; life insurance companies do not have to make most oftheir payments until well into the future, so their assets consist oflonger-termsecurities.10. Insurance companies will not provide fire insurance for the full value of yourhouse and its contents.Why not?Answer: Providing fire insurance for the full value of one's house and its contentsincreasesmoralhazard;theindividual wouldhavelessofan incentivetoprotecthishousefromburningdown andwould nottakeappropriateprecautions,suchas havingsmoke alarms and fire extinguishers.Remember, one of the solutions to the moralhazard problem is to ensure that borrowers and the insured have something of theirown- some net worth -at stake.11. What are the benefits of collaboration between a large appliance retailer andafinance company?Answer: The appliance retailer has customers walk in the door that will needfinancing to make purchases.Meanwhile, the finance company has access to fundsin financial markets.So, there are economies of scope that they two can exploitthrough collaboration.12. Why might a person who changes jobs frequently have a lower retirementincome than someone who stays with the same employer for a long time?Answer: Companies with defined-benefit pension plans base the size of the retirementincome of a former employee on the number of years the employee worked at thecompany and ontheemployee'sfinal salary.Someonewhodoesnot staywith anyparticular company for very long would have a lower retirement income.13. How do insurance companies address the problem of adverse selection?Answer: Insurance companies screen applicants and adjust their premiumsaccordingly.Someone applying for life insurance will have to undergo a physicalexamination, and someone with a poor drivingrecord will have to pay a largerpremium for car insurance.14. Earnings on the savings accumulated under a whole life insurance policy arenot taxed.Such a policy provides insurance that pays benefits when thepolicyholder dies, plus savings the policyholder can cash in before death.What would happen to the relative demand for whole life insurance ifInstructor'sManualt/aCecchetti:Money,Banking,andFinancial Markets

Chapter 8 Financial Industry Structure Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets Answer: Property and casualty insurance companies have a different time horizon from life insurance companies. Property and casualty insurance companies often have to make a large number of payments in the near future, so their assets are primarily short-term securities; life insurance companies do not have to make most of their payments until well into the future, so their assets consist of longer-term securities. 10. Insurance companies will not provide fire insurance for the full value of your house and its contents. Why not? Answer: Providing fire insurance for the full value of one’s house and its contents increases moral hazard; the individual would have less of an incentive to protect his house from burning down and would not take appropriate precautions, such as having smoke alarms and fire extinguishers. Remember, one of the solutions to the moral hazard problem is to ensure that borrowers and the insured have something of their own – some net worth – at stake. 11. What are the benefits of collaboration between a large appliance retailer and a finance company? Answer: The appliance retailer has customers walk in the door that will need financing to make purchases. Meanwhile, the finance company has access to funds in financial markets. So, there are economies of scope that they two can exploit through collaboration. 12. Why might a person who changes jobs frequently have a lower retirement income than someone who stays with the same employer for a long time? Answer: Companies with defined-benefit pension plans base the size of the retirement income of a former employee on the number of years the employee worked at the company and on the employee’s final salary. Someone who does not stay with any particular company for very long would have a lower retirement income. 13. How do insurance companies address the problem of adverse selection? Answer: Insurance companies screen applicants and adjust their premiums accordingly. Someone applying for life insurance will have to undergo a physical examination, and someone with a poor driving record will have to pay a larger premium for car insurance. 14. Earnings on the savings accumulated under a whole life insurance policy are not taxed. Such a policy provides insurance that pays benefits when the policyholder dies, plus savings the policyholder can cash in before death. What would happen to the relative demand for whole life insurance if

Chapter8Financial Industry StructureCongress passed a law making the earnings on all savings exempt from taxes?Would insurance companies be for or against such a law?Why?Answer: If Congress passed a law making the earnings on all savings exempt fromtaxes, then there would be no advantage to investing one's savings in a life insurancepolicy instead of in anothertype of account.Insurancecompanieswouldbeagainstthis because less people would purchase whole life insurance15. California experiences periodic wildfires that destroy significant numbers ofhomes.What would happen to the insurance marketif the governmentpassed a law requiring that any insurance company operating in the statemust provide fire insurance to all those homeowners who ask for it?Answer: If the insurance companies have reinsurance, then they are already willing toprovide insurance to all homeowners who ask for it.If the insurance companies donot have reinsurance, they will stop selling insurance policies or will raise thepremiums dramatically.16. Could the financial system operate without securities firms?Why or whynot?Answer:It would be difficult for the financial system to operate without securitiesWithout the underwriting services of investment banks, firms would find iffirms.very difficult to issue stock.Without brokerage firms, individual investors wouldnot have access to the financial markets.And without mutual funds, small investorswould not be able to create diversified portfolios (and so would not invest).17.An industry with a large number of small firms is usually thought to behighly competitive.Is that supposition true of the banking industry?What are the costs and benefits to consumers of the current structure of theU.S. banking industry?Answer:When the banking industry consisted ofa large number of small firms, theindustry was less competitive than it is today.This is because each small bank had amonopoly within its geographic area.As large banks branch across the country andthe number of small local banks falls, consumers benefit by having access to a largernetwork of ATMs and by being able to engage in a wider range of financial activitiesthroughtheirbanks.Coststo consumershavefallenasaresultof increasedcompetition.However, the level of personal service that consumers receive hasdeclined.18. Explain thefollowing quotation:Instructor'sManual t/aCecchetti:Money,Banking,andFinancial Markets

Chapter 8 Financial Industry Structure Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets Congress passed a law making the earnings on all savings exempt from taxes? Would insurance companies be for or against such a law? Why? Answer: If Congress passed a law making the earnings on all savings exempt from taxes, then there would be no advantage to investing one’s savings in a life insurance policy instead of in another type of account. Insurance companies would be against this because less people would purchase whole life insurance. 15. California experiences periodic wildfires that destroy significant numbers of homes. What would happen to the insurance market if the government passed a law requiring that any insurance company operating in the state must provide fire insurance to all those homeowners who ask for it? Answer: If the insurance companies have reinsurance, then they are already willing to provide insurance to all homeowners who ask for it. If the insurance companies do not have reinsurance, they will stop selling insurance policies or will raise the premiums dramatically. 16. Could the financial system operate without securities firms? Why or why not? Answer: It would be difficult for the financial system to operate without securities firms. Without the underwriting services of investment banks, firms would find if very difficult to issue stock. Without brokerage firms, individual investors would not have access to the financial markets. And without mutual funds, small investors would not be able to create diversified portfolios (and so would not invest). 17. An industry with a large number of small firms is usually thought to be highly competitive. Is that supposition true of the banking industry? What are the costs and benefits to consumers of the current structure of the U.S. banking industry? Answer: When the banking industry consisted of a large number of small firms, the industry was less competitive than it is today. This is because each small bank had a monopoly within its geographic area. As large banks branch across the country and the number of small local banks falls, consumers benefit by having access to a larger network of ATMs and by being able to engage in a wider range of financial activities through their banks. Costs to consumers have fallen as a result of increased competition. However, the level of personal service that consumers receive has declined. 18. Explain the following quotation:

Chapter8Financial Industry Structure“For the farmers who needed credit in the rural South in the early years of the2oth century, the alternatives were dismal.Few banks would even considermaking agricultural loans, and those who did charged extremely high interestrates.Rural credit was fertile ground for loan sharks, and year after year,farmers turned over their crops to help pay exorbitant interest charges on loansmade to keep their farms operating.Should a crop fail, the chances of afarmer extricating himself and his family from a loan shark's clutches werevirtually non-existent."(Raghuram G.Rajan and Luigi Zingales. SavingCapitalism from the Capitalists. New York: Crown Business, 2003, pg. 13.)Answer: Banks were unwilling to make agricultural loans to local farmers because ifthere were a bad growing season, then a large portion of thebanksborrowers woulddefault.The only wayfarmers could borrowmoney wasfrom loan sharks.Because farmers had no other options, the loan sharks could charge very high interestrates.19. When the values of stocks and bonds fluctuate, they have an impact on thebalance sheet of insurance companies.Why is that impact more likely to bea problem for life insurance companies than for property and casualtycompanies?Answer: Property and casualty insurance companies have a different investmenthorizonfrom lifeinsurancecompanies.Becausepropertyand casualtyinsurancecompanies are likely to have to make a large number of payments in the near future,they invest primarily in short-term assets, like money market instruments.Paymentsfrom life insurancecompanies don'toccur untilfar intothefuture,sotheyinvest inlonger-term instruments, including stocks andbonds.Life insurance companiesfacethe risk that they will have to sell stocks or bonds when prices are low in order to paypolicyholders'claims.20. Explain how assumptions about the rate of return on a firm's pension fundportfolio can affect a firm's profitability.Why might governmentregulators want to monitor those assumptions?Answer:If therate of returnona firm'spensionfund portfolio is high,thefirmdoesnot needto contributeasmuchmoneytothefund inordertobeabletomakethepromised payments to its retired employees.When a firm expects the rate of returnon itspensionfundtobehigh, itwill invest lessmoneyinthefund (oreventakemoney out of the fund)in order to increase its profits.However, if therate of returnis less than expected, then the firm will have difficulty meeting its obligations toretired employees.Government regulators monitor assumptions about rate of return,because many private, defined-benefit pension funds are insured by the government,so if thefirm can't meet its obligations, then the government has to step in and makepaymentstoretirees.Instructor'sManualt/aCecchetti:Money,Banking,andFinancial Markets

Chapter 8 Financial Industry Structure Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets “For the farmers who needed credit in the rural South in the early years of the 20th century, the alternatives were dismal. Few banks would even consider making agricultural loans, and those who did charged extremely high interest rates. Rural credit was fertile ground for loan sharks, and year after year, farmers turned over their crops to help pay exorbitant interest charges on loans made to keep their farms operating. Should a crop fail, the chances of a farmer extricating himself and his family from a loan shark’s clutches were virtually non-existent.” (Raghuram G. Rajan and Luigi Zingales. Saving Capitalism from the Capitalists. New York: Crown Business, 2003, pg. 13.) Answer: Banks were unwilling to make agricultural loans to local farmers because if there were a bad growing season, then a large portion of the banks’ borrowers would default. The only way farmers could borrow money was from loan sharks. Because farmers had no other options, the loan sharks could charge very high interest rates. 19. When the values of stocks and bonds fluctuate, they have an impact on the balance sheet of insurance companies. Why is that impact more likely to be a problem for life insurance companies than for property and casualty companies? Answer: Property and casualty insurance companies have a different investment horizon from life insurance companies. Because property and casualty insurance companies are likely to have to make a large number of payments in the near future, they invest primarily in short-term assets, like money market instruments. Payments from life insurance companies don’t occur until far into the future, so they invest in longer-term instruments, including stocks and bonds. Life insurance companies face the risk that they will have to sell stocks or bonds when prices are low in order to pay policyholders’ claims. 20. Explain how assumptions about the rate of return on a firm’s pension fund portfolio can affect a firm’s profitability. Why might government regulators want to monitor those assumptions? Answer: If the rate of return on a firm’s pension fund portfolio is high, the firm does not need to contribute as much money to the fund in order to be able to make the promised payments to its retired employees. When a firm expects the rate of return on its pension fund to be high, it will invest less money in the fund (or even take money out of the fund) in order to increase its profits. However, if the rate of return is less than expected, then the firm will have difficulty meeting its obligations to retired employees. Government regulators monitor assumptions about rate of return, because many private, defined-benefit pension funds are insured by the government, so if the firm can’t meet its obligations, then the government has to step in and make payments to retirees