Question12 Which of the following statement is FALSE? Select one alternative: a. A well designed deposit insurance scheme can prevent bank runs. b. Deposit insurance encourages public trust in the banking system. c. Deposit insurance can increase risk-taking behaviour of managers. d. Securitisation can increase a bank's liquidity risk. e. Deposit insurance will discourage banks to invest more in liquid assets. ResetMaximum marks: 2 Flag question undefined

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Question12 asks which statement is FALSE among the alternatives.
Option a: 'A well designed deposit insurance scheme can prevent bank runs.' This is generally considered true in many theoretical and practical discussions: a credible deposit insurance scheme reduces the perceived risk of losing deposits and can dampen panic-driven withdrawals, thereby helping to prevent bank runs when properly designed and funded.
Option b: 'Deposit insurance encourages public trust in the banking system.' This is also true in typical analyses. When depositors know their funds are insured, they are more likely to maintain confidence in the safety of their deposits, which supports financial stability and reduces runs driven by fear.
Option c: 'Deposit insurance can increase risk-taking behaviour of managers.' This is a recognized concern in moral hazard theory. By reducing the downside risk to depositors, managers may feel insulated from consequences and thus have an incentive to take on higher-risk activities, relying on the insurance to cover potential losses.
Option d: 'Securitisation can increase a bank's liquidity risk.' This claim is debated in practice. While securitisation can improve liquidity by creating more tradable funding instruments, it can also transfer or concentrate liquidity risk in ways that may be problematic during stressed market conditions. However, in many standard treatments, securitisation is viewed as a tool that can enhance liquidity management rather than unequivocally increasing liquidity risk. This nuanced view means the statement can be considered false if the emphasis is that securitisation mainly serves to increase liquidity risk, not to diversify or improve it. The key point is that securitisation does not inherently and always increase liquidity risk; its effect depends on structure, market conditions, and risk management.
Option e: 'Deposit insurance will discourage banks to invest more in liquid assets.' This statement is typically false in practice. Deposit insurance tends to reduce the marginal benefit of holding extremely high levels of liquidity and can alter risk incentives, but it does not categorically discourage all liquidity investment. In many environments, banks still maintain adequate liquidity buffers to meet regulatory and prudential standards, even with deposit insurance in place. The wording suggests a universal discouragement, which is not a necessary or universal outcome of deposit insurance.

Overall, the assertion in option d is the one designated as false in this question, given that securitisation is generally used as a liquidity management tool and its impact on liquidity risk is context-dependent rather than an unconditional increase in liquidity risk.

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