Chapter 1: Bank Management, Answers to Assigned End-of-Chapter Questions

1. Describe what happened to the following traditional banks in 2008:

a. Goldman Sachs – Converted to a bank holding company
b. Bear Stearns – Acquired by J.P. Morgan Chase.
c. Morgan Stanley – Converted to a bank holding company.
d. Lehman Brothers – Allowed to fail.
e. Merrill Lynch – Acquired by Bank of America.

2. Define the following terms and explain why they were important during the housing and credit
crisis of 2007-2009.
a. Mortgages are loans secured by real estate. They are generally recorded in county records
offices alongside real estate title information. As real estate prices declined after 2006, lenders
and homeowners confronted mortgage defaults (failure to pay by the borrower) and the negative
equity of being “upside down.”

b. Subprime loans are loans made to borrowers with low (or no!) credit scores and a higher-
than-average risk of default. Various types of subprime mortgages (ARMs, low or no-interest,
negative amortization, etc) were offered to make the monthly payments affordable.

c. Asset write-downs are when a financial institution formally recognizes that loans (or other
assets) they hold on their balance sheets are worth less than previously reported, often less than
the amount owed on the funds used to acquire those assets. The write-downs of the mid and late
2000’s, and early 2010’s, in turn, deplete the lenders’ capital or owner’s equity (recall Assets =
Liabilities + Owner’s Equity) and forced them to either sell assets or obtain additional external
capital.

4. What is the specific federal income tax treatment of a Sub S corporation bank? How are
stockholders taxed?

S-corporations, like partnerships and Limited Liability Companies, are not taxed at the corporate, or
business, level. Income and losses “pass through” to the owners according to their relative ownership
interests. An owner of 10% of a Sub-S or LLC takes 10% of the business’s income or losses directly
to his or her tax return; taxes (or tax shelters) are then assessed at the owner’s personal marginal
income tax rate.

7. Provide three reasons why the number of independent commercial banks might fall sharply over the
next few years.

1. The TARP program will encourage consolidation, which will sharply reduce the number of
independent commercial banks. 2. The increase in problem subprime loans will cause
independent commercial banks to either fail or be acquired by more financial sound banks. 3.
Independent banks have less flexibility compared to bank holding companies in terms of the
number and breadth of activities they can engage in. This reduces the competitiveness of the
independent bank.
8. List and describe the different channels that banks use to deliver banking services. For each,
describe the characteristics of the customers who will likely be active users of services in that
channel.

There are several different channels through which banks deliver their services: Branch
Banking: The two most common types of branches are standalone brick-and-mortar buildings
and in-store branches. Brick-and-mortar branches typically offer a complete set of banking
services including loans, deposits, and money management/trust services. Often they have drive-
up windows. In-store branches are typically located in retail outlets, like Wal-Mart or Kroger’s,
and offer a limited range of services. Automated Teller Machines: ATMs are computerized
telecommunications systems that offer limited bank services without direct human involvement.
Typically, the bank that owns or hosts the ATM will charge a fee to the user for the access.
Younger customers and older customers that are comfortable with technology are the likely users
of ATMs. Internet (Online) Banking: Most banks allow customers to access their account
information and conduct routine banking business via secured Web sites. Typical services include
account review, bill payment, wire transfer of funds, and applications for loans and new accounts.
The primary appeal of Internet banking is its convenience. The primary disadvantage of Internet
banking is that thieves have had success in stealing account information from individuals and
quickly depleting account balances. Younger customers are likely users of online banking. Call
Centers: These are intended to benefit a bank’s retail customers. Banks use call centers primarily
for handling customer inquiries and for telemarketing efforts and debt collection. Customers
uncomfortable with computer technology will be likely users of call centers. Mobile Banking:
This allows customers to use cell phones to conduct banking business. This speeds up
transactions processing and increases customer convenience. Younger customers will likely
prefer mobile banking.

Chapter 1: Banking and the Financial Services Industry

1. Which act separated commercial banking, investment banking and insurance into three separate
industries?
a. Glass-Steagall Act
b. Bank Holding Company Act
c. McFadden Act
d. Federal Reserve Act
e. Competitive Equality Banking Act

2. Which act limited the activities a company could engage in if it owned a bank?
a. Federal Reserve Act
b. Bank Holding Company Act
c. McFadden Act
d. Glass-Steagall Act
e. Competitive Equality Banking Act

3. Which of the following mortgage types were offered to “subprime” borrowers?

a. Interest Only
b. Option Adjustable-Rate
 c. Principal Only
d. All of the above
e. a. and b. only

4. The U.S. government took all of the following actions to address the credit crisis in 2008 except:
a. putting Fannie Mae into conservatorship.
b. passed the Troubled Asset Relief Program (TARP).
c. created the Keep Banks Solvent (KBS) agency.
d. authorized large non-financial firms to sell bonds that were FDIC-insured.
e. temporarily increased FDIC domestic deposit coverage to $250,000.

5. At the end of 2008, which of the following investment banks remained “independent?”
a. Bear Stearns
b. Goldman Sachs
c. Lehman Brothers
d. Merrill Lynch
e. a. and b.

6. In 2008, the U.S. Department of the Treasury supported financial institutions by:
a. purchasing troubled assets.
b. buying preferred stock in some financial institutions.
c. issuing guarantees on money market funds.
d. increasing the deposit insurance limit.
e. all of the above.

7. Which of the following is false regarding community banks?

a. They often have assets of well over of $1 billion.
b. They typically operate in a limited geographic area.
c. Community banks often focus on lending to small businesses.
d. A bulk of their funding comes from deposits.
e. They tend to grow at a modest rate.

8. Banks with _______ in assets are generally called community banks.

a. more than $1 billion
b. less than $1 billion
c. less than $50 million
d. less than $100 billion
e. more than $100 billion

9. An “independent” bank is:

a. an “independent” subsidiary of a multi-bank holding company.
b. another name for a one-bank holding company.
c. a bank that is exempt from paying federal income taxes.
d. a bank that is specifically created to underwrite corporate debt issues.
e. not controlled by a multi-bank holding company or any other outside interest.

10. Bank holding companies and financial holding companies generally do not pay income tax because:
a. they are always chartered as non-profit corporations.
b. most of their income is subsidiary income from which they are paid dividends (which
dividends were derived from already-taxed income), of which 80% are tax-exempt.
c. the subsidiaries always operate at a net loss.
 d. bank holding companies must carry deposit insurance.
e. bank holding companies are not subject to Internal Revenue Service regulations.

11. Controlling interest in a bank is defined as ownership or indirect control of ____ of the voting shares
in the bank.
a. 15%
b. 20%
c. 25%
d. 30%
e. 51%

12. Today, the primary motivation behind forming a bank holding company is:
a. to reduce competition.
b. the ability to circumvent restrictions on branching.
c. to broaden the scope of products the bank can offer.
d. to increase deposit concentration.
e. All of the above are motivating factors today for forming a bank holding company.

13. __________ control at least two commercial banks.

a. One-bank holding companies
b. State holding companies
c. National holding companies
d. Multibank holding companies
e. None of the above

14. The _________ gave regulatory responsibility over financial holding companies to the Federal
Reserve.
a. Riegle-Neal Interstate Banking and Branching Efficiency Act
b. Gramm-Leach-Bliley Act
c. Financial Institutions Reform, Recovery and Enforcement Act
d. Federal Deposit Insurance Corporation Improvement Act
e. Depository Institutions Deregulation and Monetary Control Act

15. Many insurance companies have formed __________ to operate banks as part of their financial
services efforts.
a. one-bank holding companies
b. multibank holding companies
c. retail subsidiaries
d. finance companies
e. financial holding companies

16. The _______________ repealed the restriction on banks affiliating with securities firms under the
Glass-Steagall Act.
a. Sarbanes-Oxley Act
b. Bank Holding Company Act
c. Competitive Equality Banking Act
d. Gramm-Leach-Bliley Act
e. Financial Institutions Reform, Recovery and Enforcement Act

17. A financial holding company cannot own which of the following?

a. A bank.
 b. A bank holding company.
c. A thrift.
d. A thrift holding company.
e. A financial holding company may own all of the above.

18. The parent bank holding company assists bank subsidiaries with all of the following except:
a. asset and liability management.
b. strategic planning.
c. loan review.
d. deposit insurance.
e. business development.

19. ___-corporations and limited liability companies have favorable tax treatment because a qualifying
firm does not pay corporate income taxes.
a. C
b. Q
c. S
d. V
e. Z

20. S-corporations must have no more than ___ shareholders.

a. 10
b. 50
c. 100
d. 500
e. 1,000

21. Deposits at credit unions are insured by the:

a. National Credit Union Association.
b. Federal Credit Union Administration.
c. Federal Reserve.
d. Federal Deposit Insurance Corporation.
e. Credit Union Insurance Corporation.

22. ______________ refers to the process of pooling a group of assets with similar features and issuing
securities that are collateralized by the assets.
a. Originate-to-Resell
b. Securitization
c. Mortgage Collateralization
d. Deposit Origination
e. Loan-to-Distribute

23. Deposit insurance was “temporarily” increased to __________ per depositor...

a. $100,000
b. $150,000
c. $250,000
d. $300,000
e. $500,000

24. The primary appeal of online banking is:

a. prevention of identity theft.
b. high-volume traffic.
c. lack of face-to-face interaction.
d. its convenience.
e. the ability to make small dollar purchases.