Operational Risk Problems and Deposit Insurance

Operational Risk Problems
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Operational Risk Problems
Explain the moral hazard problems with deposit insurance. How can they be overcome?
One of the moral hazard issues with deposit insurance is customers tend to take little or no interest in the manner in which the bank takes risks and lends, despite the customers being insured. Such lack of scrutiny from the customers implies that there is no limit to which the banks can take risks since they do not consider the extent to which the depositors would be comfortable (Anginer & Demirguc-Kunt, 2018). On the contrary, the banks are free to lend whatever amount they like and to whomever they feel like lending. As a result, this lowers the available capital ratio. This implies that deposit insurance tends to remove one possible barrier to the banks’ desire to lend, and this increases the riskiness of the banks’ lending. This problem can be overcome if customers (depositors) take more interest in the affairs of their banks and make a follow-up on the lending activities. This will keep the bank on an ethical track.
Another moral hazard issue concerns the insolvency procedures as well as the costs incurred if a bank fails. If the country has a deposit guarantee scheme, then it implies that the government can bail out the bank in the event of insolvency. Alternatively, the bank can be closed and its assets sold and the returns used to compensate deposit holders until the designated amount is achieved (Mao & Cheng, 2020). If there is no deposit guarantee scheme, depositors risk losing their money if the bank fails. However, this problem can be solved by pushing the government to offer a deposit guarantee policy, as well as ensuring that banks have the same policy so that they can compensate depositors if the bank fails.
During a certain year, interest rates fall by 200 basis points (2%) and equity prices are flat. Discuss the effect of this on a defined benefit pension plan that is 60% invested in equities and 40% invested in bonds.
When interests fall, then the value of a bond in the market increases. In this case, this means that the value of the bond portfolio in question should thus increase. However, it is worth noting that a lower discount rate is applied in determining the true value of the pension fund liabilities (Swanson, 2020). The impact of this is that it will lead to an increase in the value of the liabilities. As a result, this is likely to have a negative net impact on the pension plan. This is due to the fact that the decrease in the interest rate affects liabilities by 100% while affecting only 40% of the assets.
Explain the meanings of the terms hurdle rate, high–water mark clause, and claw- back clause when used in ...