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Banking - Essay Example

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Name of student: Running Head: Banking Economics Essay One Deposit insurance infers the protection usually given by an agency of the government to depositors to avoid risk loss arising from failure of an intermediary (bank) or other deposition body…
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Download file to see previous pages... Depository insurance can be obtained instantly and they are not traded debts since bank incentive take risks and they have no discipline from market prices. Depository insurance have a role of disciplining the management and reduction moral hazard that is, infinite maturity infers that deposits can rapidly disappear; leading to moral hazard; sequential examination also gives a benefit to monitor such services(Pastre?, 2007). Depository insurance helps in ensuring less costly and unnecessary liquidations, duplication of deposits are avoided through monitoring and less probability of runs on solvent thus reducing shock to supply of money at macro level. Depository insurance relates to bank runs in that without monitoring of projects may be vulnerable resulting into socially uneconomical of projects. Allman (2006) describes the lender of the last resort as that institution which is willing to give loans as a last option to banks or other financial institutions that are undergoing financial problem that is considered highly risky. Such a firm is usually the country’s central bank. The lender of the last resort produces currency at its discretion to support institutions facing financial problems. ...
Since they provide liquidity assistance they help curb the insolvency problem. The lender of the last resort therefore, eases smooth bank runs through recapitalizing the insolvent banks. This helps the financial institutions to enhance their consumer protection. In conclusion, both depository insurance and lender of the last resort have the one thing in common in that they tend to protect various financial institutions from insolvency challenges leading to efficient and effective bank runs. Essay Two An economic theory is a concept or an idea put forward to explain various economic aspects that exist in the world economy. Economic theories are those specifically, these theories explain the aspects in line with monetary effects and financial aspects related to the management and utilization of scarce resources exhaustively (Allman, 2006). The major theories that illustrate the existence of bank include: Economies of scale theory Here, transaction prices at core tend to increase this is due to fixed cost of evaluating assets thus reducing average costs of trading. This shows that individual cannot at any time diversify perfectly since, bank pool risk and diversify portfolio are cheaper and that the payment services are also cheaper (Pastre?, 2007). A special situation is where liquidity insurance and economies of scale in risk pulling is experienced. Liquidity focuses on the banks cashable deposits as assets are long term and illiquid. Therefore, banks as pools of liquidity gives people with insurance in opposition to idiosyncratic shocks that they can only observe. Banks also protect borrowers from early encashment of loans. Asymmetrical information theory This involves screening to overcome adverse selection whereby intermediaries screen the quality ...Download file to see next pagesRead More
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