TEST BANK
MANAGING FINANCIAL INSTITUTIONS
1ST EDITION
CHAPTER 1: FINANCIAL INSTITUTIONS AS SOCIAL VALUE CREATORS AND
FINANCIAL RISK TAKERS
SHORT QUESTIONS ANSWER AND PROBLEMS:
Q-1) Should managers of financial institutions be concerned about other stakeholders (i.e.
regulators, depositors, uninsured debt-holders, community, employees, customers)?
Explain how problems for corporate cultures for financial institutions contributed to
serious problems for financial institutions and their customers and other stakeholders
giving a recent example.
Answer: Financial institutions have obligations to consider repercussions of their strategies and
actions for all stakeholders that determine their reputation and success including stockholders,
regulators, depositors, uninsured debt-holders, community, and customers. This is particularly
the case for depository institutions that are chartered to serve their communities and to abide by
federal and state regulations. The U.S. Subprime Loan Crisis is an example of the serious
repercussions when financial institution managers fail to have good corporate governance, and
corporate cultures that value all stakeholders that add to the success and reputation of a
financial institution.
By having cultures that encouraged short-term profits and provided bonuses for making
quantities of loans versus the quality of loans and ability for borrowers to repay loans, for
instance contributed to huge numbers of bankruptcies when housing prices collapsed. Wells
Fargo’s scandal in September 2016 is another example where managers did not consider
customers as stakeholders and a corporate culture was created pushing employees for sales
goals versus serving customers’ best interests. Wells Fargo managers imposed a high-pressure
tactics on employees to push products on customers to hit sales goals. This led to fraudulent
behavior by employees, where 2 million customer accounts were opened without customers’
,knowledge. When this scandal was uncovered, Wells Fargo’s stock price plunged, and Wells
Fargo had serious reputational damage losing major clients and customers. Wells Fargo was
given a $185 million fine, and 5,300 employees were fired, and a new CEO put in place. Under
the Sarbanes-Oxley Act, Wells Fargo also violated the requirement that executives personally
required to certify that a bank has financial and operational controls in place.
(See: Matt Egan, “Wells Fargo stock sinks to 2-1/2 year low.” CNN Money, September 26,
2016, accessed on November 14, 2016 at:
http://money.cnn.com/2016/09/26/investing/wells-fargo-stock-fake-account-scandal/
and Patrick W. Watson, “Wells Fargo scandal shows next bank crisis coming.” Forbes,
September 15, 2016, accessed on November 14, 2016 at:
http://www.forbes.com/sites/patrickwwatson/2016/09/15/wells-fargo-scandal-shows-next-
bank-crisis-coming/#79b153f269ec.)
Q-2) In setting strategies for risk/return for a financial institution, what would be the likely
respective opinions of different stakeholders (stockholders, uninsured debt-holders,
regulators, managers, and insured depositors) for taking on more or less risk? Explain
why some stakeholders prefer more risk than others.
Answer: Stockholders with limited liability with a maximum loss their investment may prefer
greater risk-taking with in effect a put option where future returns on a small investment are
unlimited, but the investment loss is limited to the amount a shareholder invests. Uninsured
debt-holders, in contrast, would prefer that managers take less risk to ensure that they will be
paid back. Similarly, regulators would prefer that managers take less risk to protect the financial
system from financial institution failures, and to ensure against losses for deposit insurance
funds. Managers may or may not prefer more or less risk taking depending on bonuses, salary
incentives, and the culture of the organization, desiring to protect their own human capital, in
terms of their jobs. During the Subprime Loan Crisis, with bonus and fee incentives to make a
large volume of loans versus the quality of loans, lenders were encouraged to engage in greater
,risk taking. Depositors would prefer lower risk taking to protect the bank against failure, but
have less incentive to monitor the bank than other debt holders for insured deposits.
Q-3) Given the quote at the beginning of Chapter 1: “At its most basic definition, finance is
the act of allocating capital to individuals and businesses that want to make productive
use of it. In short finance creates social value,” discuss how financial institutions
provide benefits to individual, businesses, and an economy, giving examples for
different types of financial institutions.
Answer: Financial institutions, when they are working well, create social value by providing
funds to businesses and individuals that these borrowers in turn can use for productive
purposes. Examples include banks providing financing and guidance for small as well as
medium sized, and large businesses. This in turn provides a stimulus for economic growth.
Banks also provide social value by ensuring a stable and safe payments mechanism and by
encouraging savings. Mutual funds provide diversified investments and the means for
consumers to save for future goals, such as retirement, dream vacations, college tuition for their
children, and other financial needs. Life/Health insurance companies provide protection in the
event of adverse events and health coverage payments, and P/L companies provide protection
against property damage and liability protection in the event of adverse events. Venture capital
firms provide funds for start-ups including new innovations, such as new disruptive
technologies to help solve environmental challenges, among other examples.
Q-4) Give an example of direct finance and an example of indirect finance and the benefits
provided by financial intermediaries giving examples for depository institutions,
mutual funds, and contractual financial institutions.
Answer: With direct financing borrowers and lenders get directly together without the
assistance of a financial intermediary. With indirect financing financial intermediaries provide
indirect financing contracts and other services including liquidity, maturity, denomination,
search, monitoring, and information financial intermediation benefits.
, Examples include for depository institutions taking in deposits offering check writing services
and providing liquidity to depositors and using maturity intermediation making longer-term
loans to borrowers and providing monitoring services. Mutual funds provide diversification
services and information and professional investment, and liquidity services allowing small
investors to invest in diversified portfolios. Contractual financial institutions, such as insurance
firms and pension funds, provide maturity intermediation and investing benefits whereby
customers pay premiums that are invested for protection against the advent of adverse events in
the future, where the insurance companies invest premiums to have funds available in the
future, and pension funds take employee and employer contributions and invest these for
employees for retirement benefits in the future.
Q-5) Discuss how technology has affected financial institutions, giving examples of both
increased opportunities and risks for FIs with new technologies. Give some examples.
Answer: Financial institutions have both increased opportunities and risks with new
technologies. Increased opportunities include new technology for financial institutions to use
and make payments easier for customers, such as new payment apps and mobile banking and
new developments for the use of block chain technology for making secure payments, and
having FinTech subsidiaries that make investment and other financial services more accessible
and easier for customers. Technological advances have also reduced the use of checks, lowering
bank costs. Risks are greater use of direct financing such as technology allowing large,
creditworthy corporations to issue commercial paper, bonds, and engage in direct finance
globally. From the standpoint of risks, financial institutions have competitive risks from
FinTech firms and high tech firms including non-bank technology firms are able to enter the
payments arena. Examples of technological firms entering the payment arena include Apple,
Google, Amazon, Facebook, and Samsung, and the development of digital payment apps,
among many others. Technology has also increased the risks of technological failures, hacking,
and fraud and embezzlement.
MANAGING FINANCIAL INSTITUTIONS
1ST EDITION
CHAPTER 1: FINANCIAL INSTITUTIONS AS SOCIAL VALUE CREATORS AND
FINANCIAL RISK TAKERS
SHORT QUESTIONS ANSWER AND PROBLEMS:
Q-1) Should managers of financial institutions be concerned about other stakeholders (i.e.
regulators, depositors, uninsured debt-holders, community, employees, customers)?
Explain how problems for corporate cultures for financial institutions contributed to
serious problems for financial institutions and their customers and other stakeholders
giving a recent example.
Answer: Financial institutions have obligations to consider repercussions of their strategies and
actions for all stakeholders that determine their reputation and success including stockholders,
regulators, depositors, uninsured debt-holders, community, and customers. This is particularly
the case for depository institutions that are chartered to serve their communities and to abide by
federal and state regulations. The U.S. Subprime Loan Crisis is an example of the serious
repercussions when financial institution managers fail to have good corporate governance, and
corporate cultures that value all stakeholders that add to the success and reputation of a
financial institution.
By having cultures that encouraged short-term profits and provided bonuses for making
quantities of loans versus the quality of loans and ability for borrowers to repay loans, for
instance contributed to huge numbers of bankruptcies when housing prices collapsed. Wells
Fargo’s scandal in September 2016 is another example where managers did not consider
customers as stakeholders and a corporate culture was created pushing employees for sales
goals versus serving customers’ best interests. Wells Fargo managers imposed a high-pressure
tactics on employees to push products on customers to hit sales goals. This led to fraudulent
behavior by employees, where 2 million customer accounts were opened without customers’
,knowledge. When this scandal was uncovered, Wells Fargo’s stock price plunged, and Wells
Fargo had serious reputational damage losing major clients and customers. Wells Fargo was
given a $185 million fine, and 5,300 employees were fired, and a new CEO put in place. Under
the Sarbanes-Oxley Act, Wells Fargo also violated the requirement that executives personally
required to certify that a bank has financial and operational controls in place.
(See: Matt Egan, “Wells Fargo stock sinks to 2-1/2 year low.” CNN Money, September 26,
2016, accessed on November 14, 2016 at:
http://money.cnn.com/2016/09/26/investing/wells-fargo-stock-fake-account-scandal/
and Patrick W. Watson, “Wells Fargo scandal shows next bank crisis coming.” Forbes,
September 15, 2016, accessed on November 14, 2016 at:
http://www.forbes.com/sites/patrickwwatson/2016/09/15/wells-fargo-scandal-shows-next-
bank-crisis-coming/#79b153f269ec.)
Q-2) In setting strategies for risk/return for a financial institution, what would be the likely
respective opinions of different stakeholders (stockholders, uninsured debt-holders,
regulators, managers, and insured depositors) for taking on more or less risk? Explain
why some stakeholders prefer more risk than others.
Answer: Stockholders with limited liability with a maximum loss their investment may prefer
greater risk-taking with in effect a put option where future returns on a small investment are
unlimited, but the investment loss is limited to the amount a shareholder invests. Uninsured
debt-holders, in contrast, would prefer that managers take less risk to ensure that they will be
paid back. Similarly, regulators would prefer that managers take less risk to protect the financial
system from financial institution failures, and to ensure against losses for deposit insurance
funds. Managers may or may not prefer more or less risk taking depending on bonuses, salary
incentives, and the culture of the organization, desiring to protect their own human capital, in
terms of their jobs. During the Subprime Loan Crisis, with bonus and fee incentives to make a
large volume of loans versus the quality of loans, lenders were encouraged to engage in greater
,risk taking. Depositors would prefer lower risk taking to protect the bank against failure, but
have less incentive to monitor the bank than other debt holders for insured deposits.
Q-3) Given the quote at the beginning of Chapter 1: “At its most basic definition, finance is
the act of allocating capital to individuals and businesses that want to make productive
use of it. In short finance creates social value,” discuss how financial institutions
provide benefits to individual, businesses, and an economy, giving examples for
different types of financial institutions.
Answer: Financial institutions, when they are working well, create social value by providing
funds to businesses and individuals that these borrowers in turn can use for productive
purposes. Examples include banks providing financing and guidance for small as well as
medium sized, and large businesses. This in turn provides a stimulus for economic growth.
Banks also provide social value by ensuring a stable and safe payments mechanism and by
encouraging savings. Mutual funds provide diversified investments and the means for
consumers to save for future goals, such as retirement, dream vacations, college tuition for their
children, and other financial needs. Life/Health insurance companies provide protection in the
event of adverse events and health coverage payments, and P/L companies provide protection
against property damage and liability protection in the event of adverse events. Venture capital
firms provide funds for start-ups including new innovations, such as new disruptive
technologies to help solve environmental challenges, among other examples.
Q-4) Give an example of direct finance and an example of indirect finance and the benefits
provided by financial intermediaries giving examples for depository institutions,
mutual funds, and contractual financial institutions.
Answer: With direct financing borrowers and lenders get directly together without the
assistance of a financial intermediary. With indirect financing financial intermediaries provide
indirect financing contracts and other services including liquidity, maturity, denomination,
search, monitoring, and information financial intermediation benefits.
, Examples include for depository institutions taking in deposits offering check writing services
and providing liquidity to depositors and using maturity intermediation making longer-term
loans to borrowers and providing monitoring services. Mutual funds provide diversification
services and information and professional investment, and liquidity services allowing small
investors to invest in diversified portfolios. Contractual financial institutions, such as insurance
firms and pension funds, provide maturity intermediation and investing benefits whereby
customers pay premiums that are invested for protection against the advent of adverse events in
the future, where the insurance companies invest premiums to have funds available in the
future, and pension funds take employee and employer contributions and invest these for
employees for retirement benefits in the future.
Q-5) Discuss how technology has affected financial institutions, giving examples of both
increased opportunities and risks for FIs with new technologies. Give some examples.
Answer: Financial institutions have both increased opportunities and risks with new
technologies. Increased opportunities include new technology for financial institutions to use
and make payments easier for customers, such as new payment apps and mobile banking and
new developments for the use of block chain technology for making secure payments, and
having FinTech subsidiaries that make investment and other financial services more accessible
and easier for customers. Technological advances have also reduced the use of checks, lowering
bank costs. Risks are greater use of direct financing such as technology allowing large,
creditworthy corporations to issue commercial paper, bonds, and engage in direct finance
globally. From the standpoint of risks, financial institutions have competitive risks from
FinTech firms and high tech firms including non-bank technology firms are able to enter the
payments arena. Examples of technological firms entering the payment arena include Apple,
Google, Amazon, Facebook, and Samsung, and the development of digital payment apps,
among many others. Technology has also increased the risks of technological failures, hacking,
and fraud and embezzlement.
