Asked by Jasmine Montero on May 25, 2024
Verified
Describe the role of bank leverage in bank insolvency during times of falling asset prices.
Bank Leverage
The ratio of a bank's total debt to its equity capital, indicating the extent to which bank funding is used to finance its assets.
Bank Insolvency
A condition where a financial institution's liabilities exceed its assets, rendering it incapable of meeting its obligations.
- Delve into the critical role of bank reserves, understand the money multiplier effect, and discern how fractional reserve banking influences changes in the money supply.
Verified Answer
SJ
Sumit JalanMay 27, 2024
Final Answer :
As bank asset values fall, the effect on bank capital is amplified by the amount of bank leverage. In modern economies where banks operate with relatively high leverage ratios, only a small decrease in asset values can completely wipe out bank capital. The loss in value of mortgage-backed assets after the housing bubble burst in 2008, many banks faced insolvency. To help maintain stability in the banking sector, the Fed took an active role in adding liquidity to the banking system.
Learning Objectives
- Delve into the critical role of bank reserves, understand the money multiplier effect, and discern how fractional reserve banking influences changes in the money supply.