Question 1: bank supervision and examination
Purpose: The purpose of bank supervision and examination is to ensure the safety, soundness,
and stability of the banking system, ultimately protecting depositors, maintaining public
confidence, and minimizing risks to the financial system.
On-Site Supervision activities
1. Financial Check-Up: Supervisors visit the bank to examine its finances, looking at loans,
assets, and overall stability.
2. Risk Management Review: They assess how the bank handles risks like credit and
operational risks.
3. Regulation Compliance: Supervisors ensure the bank follows all essential rules to stay
safe and secure.
Off-Site Supervision activities
1. Monitoring Financial Data: Supervisors review financial reports that banks submit
regularly, keeping an eye out for any red flags.
2. Checking Compliance Standards: They verify that the bank meets regulatory standards,
like required capital levels.
3. Detecting Early Warnings: Supervisors use tools to identify potential issues, like sudden
changes in loan quality.
Question 2: Interest rates in banking
Interest rates can be defined as the cost of borrowing money or the return on savings, which is
normally expressed as a percentage
They are considered crucial for the following reasons
1. Influence on Economic Activity: Interest rates affect consumer spending, business
investments, and overall economic growth. Lower rates encourage borrowing and
spending, while higher rates can reduce demand and control inflation.
2. Cost of Credit and Access to Capital: They directly determine the cost of borrowing,
impacting how accessible credit is for individuals and businesses. This influences
everything from homeownership to business expansions.
3. Monetary Policy Tool: Central banks use interest rates as a primary tool to control
inflation, stabilize the economy, and manage currency value, making them essential for
financial stability.
Types of interest rates
1. Fixed Interest Rate: This rate remains constant for the entire term of the loan or deposit,
providing predictability in payments or returns without being affected by market changes.
2. Simple Interest Rate: Calculated only on the original principal, simple interest doesn’t
compound, meaning you pay or earn the same interest amount each period. It’s common
in short-term loans or straightforward savings accounts.
3. Compound Interest Rate: Interest is calculated on both the initial principal and any
accumulated interest from previous periods. This leads to faster growth over time,
making it beneficial for savings but costlier for long-term loans.
4. Floating (Variable) Interest Rate: Tied to a benchmark rate, this rate can change over
time, impacting monthly payments or earnings. It’s commonly used in adjustable-rate
mortgages or credit cards, adjusting with market conditions.
5. Discounted Interest Rate: This rate is deducted upfront from the loan amount, so the
borrower receives a reduced amount. Often seen in short-term loans, it allows the bank to
apply interest in advance
Question 3: Role of Financial Intermediaries in Handling Moral Hazard and adverse
selection Problems
To Overcome Adverse Selection:
1. Screening: Banks assess the creditworthiness of borrowers through thorough checks and
financial analysis to avoid lending to high-risk individuals.
2. Risk Pooling: By lending to a diverse group of borrowers, financial intermediaries spread
the risk, reducing the impact of defaults.
To Overcome Moral Hazard:
1. Monitoring and Incentive Structures: Banks actively monitor borrowers and may require
collateral or set performance-based terms to encourage responsible use of loan funds.
2. Loan Covenants: Financial intermediaries include conditions in loan agreements, such as
maintaining financial ratios, to limit risky borrower behavior and ensure accountability.
