What happens when a large bank becomes insolvent and closes?A.Depositors at the failed bank lose confidence and invest in the stock market, causing stock prices to rise.B.Depositors at other banks, fearing their banks may also fail, rush to withdraw their money, potentially triggering more bank failures due to insufficient reserves.C.The closure of one large bank has no effect on other banks, as each bank operates independently of one another.D.Other banks, learning from the failure, quickly adjust their policies to mitigate risks and prevent future bank failures.
Question
What happens when a large bank becomes insolvent and closes?A.Depositors at the failed bank lose confidence and invest in the stock market, causing stock prices to rise.B.Depositors at other banks, fearing their banks may also fail, rush to withdraw their money, potentially triggering more bank failures due to insufficient reserves.C.The closure of one large bank has no effect on other banks, as each bank operates independently of one another.D.Other banks, learning from the failure, quickly adjust their policies to mitigate risks and prevent future bank failures.
Solution
The correct answer is B. Depositors at other banks, fearing their banks may also fail, rush to withdraw their money, potentially triggering more bank failures due to insufficient reserves. This is known as a bank run. When a large bank becomes insolvent and closes, it can create a panic among depositors who may start to worry about the safety of their own deposits, even at other banks. If these fears spread, it can lead to a bank run where a large number of customers withdraw their money from a bank because they fear it will become insolvent. If a bank run occurs, it can cause the bank to actually become insolvent, as banks typically do not have enough cash on hand to cover all deposits. This can potentially lead to more bank failures.
Similar Questions
If a large bank becomes insolvent and closes, it could cause furtherinstability in the banking system. Why? (more than one answer may be correct)This is a multi answer question. You can select one or more options as the answer.A.If depositors realise that another bank failed, they suspect their bankmay fail, triggering bank runs where depositors rush to their banks towithdraw as much as possibleB.Money supply reduces as a result of a households not withdrawing their deposits and holding their saving as currency.C.If banks do not hold sufficient reserves to meet the sudden increase inwithdrawal demands, they might become insolvent and eventually mustclose, which triggers even more bank runs
1. Depositors lack of information about the quality of bank assets can lead to A) bank panics. B) bank booms. C) sequencing. D) asset transformation. 2. The contagion effect refers to the fact that A) deposit insurance has eliminated the problem of bank failures. B) bank runs involve only sound banks. C) bank runs involve only insolvent banks. D) the failure of one bank can hasten the failure of other banks.
If uncertainty about banks' health causes depositors to begin to withdraw their funds frombanks, the country experiences a(n)A) banking crisis.B) financial recovery.C) reduction of the adverse selection and moral hazard problems.D) increase in information available to investors.
What happens in economies where people do not trust banks
Do you think that the Central Bank’s role as a lender of last resort leads financial institutionsto make more risky investments? What problems might the economy face if these institutionswere left to fail?
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.