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# Regulatory bodies

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1. Explain how do banks create money? What is money multiplier?

2. American (and world) history is rich with examples of bank crises, often the result of overly expansive loan policies by private banks. As recently as 2007, subprime bank loans (real estate loans made to borrowers with relatively poor credit ratings) have resulted in a significant increase in mortgage defaults. What role, if any, should the Federal Reserve (or other bank regulatory bodies) play in monitoring and remedying these crises?

3- The yield curve reflects interest rates over different maturities for a given debt instrument, like 10-year treasury bonds, or 3-month treasury bills, as well as for private debt. What can you conclude about an upward-sloping yield curve? What if the yield curve becomes inverted (downward-sloping)?

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#### Solution Preview

1) Banks creat money by taking in deposits, keep a small percentage in the vaults, and lending out the rest. But they can do this for every loan multiple of times. For example, if banks are required to hold 5% of their loans as cash in their vaults, they can multiply that cash via loans by 20 times (100%/5%). In other words, only \$5 to support a \$100 loan. So, if a bank takes in \$5 million in loans in one year, the bank could loan out \$100 million in loans. That is how banks can multiply money. So, if the government would require banks to hold 10% of their loans in cash, then the multiplier would be cut in half to only 10 times (100%/10%).

2) Regulatory bodies must make sure that all that banks lend out, no matter what kind of label they use (sub-prime mortgages and all other manner of securitized assets), is reported accurately on their books. So, if banks are required to hold 5% ...

#### Solution Summary

Banking regulatory bodies are assessed.

\$2.19