Assignment 3: and Sur ……………………………………………. Exercise 40 points) According the the articles of ” (Alastair Darling, A crisis needs a firewallnot a ringfence, Financial Times, 4 Feb 2013) and (Martin Wolf, Of course its right to ringfence the rogue universals, Sep 16, 2011) a) Briefly describe what Alistair Darling means by “ringfencing”, and how it might help prevent a banking collapse such as RBS Response According to the article, ring fencing is the transfer of a bank’s assets from one account destination to another. This is usually done through the use of offshore accounting.
The motive of this accounting exercise is to protect the RBS bank against inclusion in an investors quantifiable net worth or to decrease the tax consequences. Ring fencing will prevent the RBS bank from collapsing as the bank will bear less tax burden and in case of litigation, the bank will not be forced to offset debts since only little assets are available in books. This means that the net worth of the business is disguised from creditors and other interested parties b) Do Alastain Darling and Martin Wolf agree, disagree or partially agree about the effectiveness of ringfenching?
Why? Response According to the article, Alastain Darling and Martin Wolf partly agree with the effectiveness of ring fencing. In the articles, the duo has described various advantages that the RBS bank can accrue upon effecting the process of ring fencing. In this case, they declare that the procedure is important for bank as the assets of the shareholders are secured. In addition, the bank will shield itself from excessive tax burden. However, they have also cited various challenges that the bank is likely to experience if the ring fencing technique is adopted.
As such, the bank may end up losing the customer loyalty as a result of cash flow problem. Again, the creditworthy of the bank will definitely reduce since there are only a few assets reflected in the books of account. This basically means that the two do not completely support the technique and hence they must have only agreed partially. c) Briefly describe the further measures (e. g., on bank capital and lending, or EU measures) that Darling proposes: Response The following measures have been further proposed by the Darling proposes Structured Finance is a technique used to transfer risk using corporate and complex legal system.
Judgment Proofing is a technique that can be used to protect the bank from being declared bankrupt. d) Briefly explain why governments need to “manage” banks in the first place: Response The government mostly uses commercial banks to control the money supply in the economy. When there is a lot of money circulating, the government applies various techniques to reduce the supply.
Similarly, the government reverses the techniques to increase money supply. All this is done to regulate the economy and to prevent it from collapsing. Therefore it is important to regulate the banking sector to avoid adverse effects on the economy. It is important to note that commercials banks have subscribers who are the shareholders. In this case, the government has to manage the sector so as to protect the interests of the shareholders. Exercise 2 (60 points) 1) Explain the phenomenon of money creation with fractional reserve banking using a numerical example with reserve ratio R=25%. Response Money creation is the process by which money supply within a country is increased.
In this case, when banks give loans, they directly increase the money supply in the economy. For example M=1/R where M is the money multiplier and R is the reserve ratio. In this case, M=1/0.25 since R=25% =0.25. Therefore, M= 4. This implies that for any amount that the bank lend to individuals, there is a multiplier of 4 unit. . 2) Examine some of the problems governments and central banks face in trying to control the money supply and present any exceptional policies they might use to deal with these problems.
Response Large number of non-banking financial institutions. These institutions cannot be directly influenced by the federal banks and hence it is hard to effectively control money supply as they play a significant role in availing money to the general public. High liquidity in commercial bank will hinder the effectiveness of actions by the federal bank. In this case, the commercial bank has huge amount of money such that actions such as discount rate has insignificant effects on these banks Effects of foreign banks are also significant.
In this case, a good number of people own bank accounts with other countries. As such, the federal bank cannot influence these banks Other people do not make deposits in bank. They keep their money in terms of stock and other valuables. 3) If the ECB wanted to use three of its policy tools to decrease the money supply, what would it do? Use of open market operation (OMO)where the ECB would sell government bonds so that they can reduce money supply Increasing bank reserve by commercial bank.
In this case, the ECB will require all commercial bank to increase the amount of money that they are required to deposit in the ECB bank. Purchases of foreign currencies so that the local currency bcan reduce.