Bank depositors in the United States are all financially protected aga

Question

Bank depositors in the United States are all financially protected against bank failure because the government insures all individuals' bank deposits. An economist argues that this insurance is partly responsible for the high rate of bank failures, since it removes from depositors any financial incentive to find out whether the bank that holds their money is secure against failure. If depositors were more selective, then banks would need to be secure in order to compete for depositors' money.

The economist's argument makes which of the following assumptions?

(A) Bank failures are caused when big borrowers default on loan repayments.
(B) A significant proportion of depositors maintain accounts at several different banks.
(C) The more a depositor has to deposit, the more careful he or she tends to be in selecting a bank.
(D) The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures.
(E) Potential depositors are able to determine which banks are secure against failure.

Similar question:  LINK

Situation  An economist contends that the high rate of bank failures can partly be blamed on federal insurance of bank deposits. The insurance removes any financial incentive for depositors to seek those banks that are the most secure against failure. In the absence of more selective depositors, the banks need not be secure to compete for deposits.

Reasoning   What assumption underlies the economist's argument?  The economist argues that banks would have to be more secure in a competitive environment with more discriminating depositors. The economist encourages potential depositors to be  more selective  in choosing a bank and therefore must believe that many depositors have sufficiently sound ideas about what makes a bank secure against failure and can often apply those ideas in determining which banks are secure.

(A) Although this statement explains how a bank failure may occur, it is not a necessary assumption for the economists argument about how depositors choose a bank.

(B) The argument never discusses multiple accounts. so this statement cannot be assumed.

(C) The economist argues that depositors are not careful in selecting banks; this statement contradicts that position, at least for some depositors, so it cannot be assumed.

(D) In arguing about choosing banks, the economist mentions nothing about the relation of interest rates to bank failures, so this statement is not assumed.

(E) Correct.  This statement properly identifies the economists underlying assumption that potential depositors are able to determine which banks are more secure.

The correct answer is E.

Giving potential depositors a financial incentive to select only secure banks will not lead to increased bank security unless the potential depositors can distinguish banks that actually are secure from those that are not. Choice E is a statement of this prerequisite and is thus the best answer.

pqhai · Accepted Answer

Hi swati007

I'm glad to help.

GENERAL THEORY  
First of all, to get a correct answer in assumption question, the  first and most important thing is determine conclusions correctly . Please note that, there is a lot of information in an argument, but you just need to attack the question/assumption you're being asked. That makes GMAT more difficult than normal tests.

Back to this question, the argument uses a famous critical thinking logic  "Conditional Reasoning". 
 The form is: 
 (1) If A, then B
(2) A
(3) Conclusion: Therefore B

Apply to this question:  
(1)  If  depositors were more selective,  then  banks would need to be secure in order to compete for depositors' money
(2) ..............????? 
(3)  Therefore,  banks would need to be secure in order to compete for depositors' money

Now you see the conclusion more clearly ==>  The missing part (2) is the assumption.  What is (2)? You can apply the form above, and get the assumption very easy: depositors were able to be more selective in determining which bank is secure.

WHY D IS WRONG?  
D say: The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures
Ask yourself: is this the assumption of the conclusion "banks would need to be secure in order to compete for depositors' money". Not at all. The  main point  of the conclusion is " need  more sure to compete  for depositors' money ". But D talks about "the factor of bank failures". They don't match at any point.

TAKEAWAY:  
In Assumption questions, determine the correct conclusions is KEY
There is a lot of info in the argument, Just focus on what you are being asked.

Hope that helps.

Regards.

GMATNinja · Answer

The economist does not argue that insurance is PRIMARILY responsible for the high rate of bank failures. Rather, the economist argues that the government insurance is PARTLY responsible for bank failures. See how one little word can change the entire meaning?

So it is certainly possible that the difference in interest rates described in choice (D) is a significant factor in bank failures. That does not mean that it is the ONLY factor. Both the government insurance and the difference in interest rates can influence bank failures.

Similarly, diet is a major factor in cholesterol levels. Does that mean that exercise can't also be a factor? Of course not. There can be multiple factors (and even multiple  significant  factors) affecting the same thing.

Thus, choice (D) is not a required assumption.

KarishmaB · Answer

Depositors are insured by the Govt for their deposits. (Even if banks fail, the Govt will refund their deposits in the bank)
So these people have no incentive to find out whether a bank is secure. (Since their money is safe one way or the other, they don't care whether the banks are safe)
If depositors were selective (they chose banks as per how secure it is), banks would need to be secure.

Conclusion - This insurance provided by the Govt to depositors is partly responsible for bank failures.

What are we assuming here? That depositors are capable of finding out whether a bank is secure. 
The argument is blaming the insurance policy claiming that without it depositors would find out whether banks are secure and hence be selective which will force banks to be secure. But in all this, we are assuming that investors are able to find out whether banks are secure. What if they are not able to even if they want to find out? Then, insurance or no insurance, depositors will not be able to be selective even if they wish to be.
Hence, insurance will have no role to play in bank failures in that case and our conclusion will fall apart.

This is given by option (E).

Look at the other options. We need an assumption. Something that will strengthen our conclusion and is necessary for our conclusion.

(A) Bank failures are caused when big borrowers default on loan repayments.

We are not assuming that this is how bank failures occur. It doesn't even strengthen our conclusion.

(B) A significant proportion of depositors maintain accounts at several different banks.

We are not assuming this. We don't need to be true for our conclusion.

(C) The more a depositor has to deposit, the more careful he or she tends to be in selecting a bank.

We are saying that depositors are not careful in selecting a bank. If anything, this is against our premises.

(D) The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures.

We are not assuming that there is no other significant factor. We are saying that insurance given to depositors by the Govt is one of the factors.

Answer (E)

Sneha2021

packem · Answer

IMO I think its E.

Analyzing choice B:
The argument says  An economist argues that this insurance is partly responsible for the the high rate of bank failure 
So, the insurance is not fully responsible for the issue at hand.Moreover,even if the depositors held accounts in several different banks, that does not guarantee a high rate of bank failures. Implies not necessary "B" is assumed.

However, only if the potential depositors are aware of the risks of bank failures, can they be more selective.

x2suresh · Answer

I will agree with E too.

Conclusion:
If depositors were more selective, then banks would need to be secure in order to compete for depositors' money.

negate E ..Potential depositors are  not  able to determine which banks are secure against failure.

then conlcusion falls apart.

pqhai · Answer

This is one of very classic logics used in GMAT.
  YOU WILL DO, ONLY IF YOU"RE ABLE TO DO.

If you  negate  the assumption, the  conclusion is broken.  
You are not able to do X, you will not do X.

Apply to this question:
Depositor will select bank carefully, only if they have ability to determine which banks are secure against failure.

If you don't believe, use   NEGATION   technique.
Depositors do NOT have ability to determine, >>> They will NOT select bank carefully.

E clearly states that.

Hope it helps.

swati007 · Answer

@pqhai,

Hi,

why option D is incorrect?
if X->Y, then assumption could be that Y --x-->X(Y will not cause X)
or A->Y(A will cause Y)
In option D, aint we trying to do this --it assumes other cause (interest rate) as the reason of bank failures?

Someone, Please explain

blueseas · Answer

hi,
i am not an expert.... :-D
argument is like this:
let suppose Mr X belongs to US
Now according to argument whatever money MR X deposits in any bank of US....is safe also when bank becomes bankrupt==>this is because all the depositors money are insured by the government. hence you can say MR X never uses his brain in order to select bank for deposition.
now author is saying this is the reason for higher rate of bank failiures.
NOW if government now doesnt insures money of depositors then people like MR X will become selective in choosing bank in order to have more security for their money ....then a competetion will rise among different banks in order to grab customers.

here conclusion is:  If depositors were more selective, then banks would need to be secure in order to compete for depositors' money

Sakshamachiever · Answer

Hi Experts,

In this question
Bank depositors in the United States are all financially protected against bank failure because the government insures all individuals' bank deposits. An economist argues that this insurance is partly responsible for the high rate of bank failures, since it removes from depositors any financial incentive to find out whether the bank that holds their money is secure against failure. If depositors were more selective, then banks would need to be secure in order to compete for depositors' money.

The economist's argument makes which of the following assumptions?

(A) Bank failures are caused when big borrowers default on loan repayments.
(B) A significant proportion of depositors maintain accounts at several different banks.
(C) The more a depositor has to deposit, the more careful he or she tends to be in selecting a bank.
(D) The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures.
(E) Potential depositors are able to determine which banks are secure against failure.

I see the official answer is E) and it does make sense.
When I solved this question I selected D):

My doubt is that in the question it was mentioned that Insurance is primarily responsible for high rate of bank failures,then would D) be the correct answer as it provides an alternate reason and negation of D would imply that the difference in interest rated is a significant factor in bank failures.

Could you please confirm ?

Thanks,
Saksham

dcummins · Answer

The argument is that insurance eliminates the incentive for depositors to investigate the financial security of their banks and thus is partly responsible for the high rate of bank failure.

Assumption

A- nothing is assumed about the mechanism of failure, just the case of failure
B - Incorrect as this isn't necessary for the argument to be true.
C - Again, not necessary for the argument to be true. What if each depositor only ever put in $1, but more financially secure banks attracted more customers?
D - This MAY or MAY NOT be true. Either way the argument only says insurance is 'partly' responsible
E - is absolutely necessary. The insurance protects depositors IS NEEDED if depositors are incapable of determining the financial security of a bank.

Sneha2021 · Answer

KarishmaB   GMATNinja 
Hi Experts, 
1) What's the conclusion of the argument? 
My understanding is that "insurance is partly responsible for the high rate of bank failures" is conclusion of the argument and then author explains the reason "depositors don't have incentive to select a bank, so banks are not competitive right now and leads to failure sometimes"
2) Can you please explain the logical flow of the argument?
3) Why E is correct? - The conclusion holds true that insurance partially led to failures whether depositors are able to determine risky banks or not.

GMATNinja · Answer

You're correct, the economist concludes that "insurance   is partly responsible for the high rate of bank failures."

To reach this conclusion, the economist offers the following chain of logic:

The government financially protects bank depositors by insuring their money that is deposited in banks. 
 Because of this, depositors have no incentive to find out whether a bank is secure or not. Who cares, if the money is insured anyway! 
 Because depositors don't care about how secure banks are, now  banks have no incentive to become more secure .

So the insurance leads to no one caring how secure banks are, and thus is partly to blame for the high rate of bank failures.

How would the economist fix this issue? Notice that in the last line of the argument that he/she says, " If depositors were more selective , then banks would need to be secure in order to compete for depositors' money."

Here, the argument assumes that consumers COULD be selective, if they had any incentive to do so. Without this capability, the entire chain of logic falls apart -- if consumers have no idea how to find the most secure banks, then removing the insurance wouldn't make a difference at all. Banks STILL wouldn't have to worry about competing for customers by becoming more secure. The economist's reason for hating insurance is that it makes consumers less picky, so we need to assume that they COULD be picky in the event that the insurance went away.

So, we need to assume (E).

I hope that helps!

Fido10 · Answer

Dear  GMATNinja , please can you help me on this one !
 we could still conclude that insurance partially led to failures whether depositors are able to determine risky banks or not !
why do we, MANDATORY, need to assume that consumers are able to determine which are the risky banks, to conclude that insurance partially led to failures !
Does not the first part of argument sufficient to conclude this conclusion ?

Thanks a lot

GMATNinja · Answer

The argument concludes that the insurance is "partly responsible for the high rate of bank failures." But why? How could an insurance policy  cause  a high rate of bank failures?

Well, according to the economist, the insurance  affects  how depositors choose banks. In other words, the insurance  causes  them to ignore whether a bank is likely to fail or not. This reduces banks' incentive to be secure against failure.

Taking that a step further -- according to the argument, if banks aren't pressured by depositors to secure against failure, they are more likely to fail. Hence, the ultimate effect of the insurance is to make banks in general more likely to fail.

Let's now consider (E):

Notice that this must be true for the argument to hold.

Keep in mind that the argument hinges on the idea that the insurance  affects  depositors' behavior. More specifically, the insurance prevents depositors from being selective about which banks to use, which in turn reduces the pressure on banks to secure against failure.

But for all that to be true, we'd need to assume that depositors can  actually differentiate  between banks that are secure against failure and those that aren't. Because if depositors  couldn't  distinguish between secure and insecure banks, then insurance would have no effect on their behavior.

From another angle: what if we assume that depositors cannot determine which banks are secure? If that were true, then even if the insurance were eliminated, depositors wouldn't reduce their deposits to insecure banks, since they wouldn't know which banks actually ARE insecure. And if that were the case, we couldn't conclude that the insurance is affecting people's behavior, at which point the argument would fall apart.

The bottom line is that for the argument to hold, we'd need to assume that bank depositors actually COULD incentivize banks to be secure. If they couldn't do this, we couldn't blame the insurance. Because even if the insurance were eliminated, people would still deposit in both secure and insecure banks (since they wouldn't be able to tell the difference).

For all those reason, (E) is a necessary assumptions, which makes it correct.

I hope that helps!

Contropositive · Answer

Hi  GMATNinja

I know OG is supreme, and there is no point fighting with the OA, but i find (E)lil loose. 
Below are my concerns:

If depositors  were  more selective ----> then banks  would need  to be secure in order to compete for depositors' money.

So, an analogous to the stimulus: If i were a Roger Federer fan, i would want him to play Wimbledon'24.

Does the stimulus require that i NEED to be a Roger Federer fan? Maybe i am or Maybe i am not, but the conclusion still holds!
On that basis, can i say that if given a better choice (F) we can dump (E)?

I have done 400-500 LSAT LR questions, and now that i have come back to OG, i find it hard to adjust to the OG language.
I don't understand why i find LSAT LR questions easier than GMAT CR. I have found that GMAT CR answer choices are less than ideal and loose. Moreover, options in LSAT LR are easier to eliminate than in GMAT CR. Are my concerns valid? How do i overcome this? Please guide.

GMATNinja · Answer

LSAT LR questions can have a slightly different feeling than GMAT CR questions -- sometimes LSAT questions feel more like intricate puzzles with clear and satisfying answers, while GMAT questions feel a bit more like they're testing common sense.

That said, they are very similar to one another, and official LSAT LR and GMAT CR questions are created and tested with extreme care. The process that works for one of them works just as well as for the other, and GMAT questions are as logically sound as LSAT questions. It's just important to get back into official GMAT questions before your test so that you can get used to the slightly different feeling of those questions.

Taking a look at your analysis: there's a difference between your example and the official passage. In your example, the "if" just sets a condition that guarantees that the conclusion will follow. But, as you've said, there's nothing saying that the opposite ISN'T true -- maybe you would STILL want Federer to play even if you're not a fan.

The passage, by contrast, sets up a specific chain of logic that ends in this conclusion: "  insurance is partly responsible for the high rate of bank failures."

WHY does the author believe this? Because depositers have no incentive to choose a "safe" bank. If they WERE more selective, then banks would have to be safer. For this chain of logic to hold up, we NEED to assume that the depositers  can actually choose a safer bank .

Could there be  other  reasons that banks would need to be more secure, just as there may be other reasons for you to want to see Federer play? Sure -- but we're looking for an assumption on which the line of reasoning presented in the passage depends. For that  exact  argument to hold up, we need to know that "potential depositors are able to determine which banks are secure against failure."

So, while it is important to notice the word "if," you can't treat it exactly the same for every argument. You have to look at the context of the whole passage and consider the exact question that is being asked.

I hope that helps!

Contropositive · Answer

Hi   GMATNinja 
Thankyou so much for thinking to explain in such detail. I think, i got the logic.

Stimulus says: 
Depositors more selective ---> bank would need to be secure to compete for money
Since, Gov. removes financial inputs --->Gov. insurance is PARTLY responsible for bank failures

''One can object and say: Hey, these Bank depositors were Incompetent in the first place, hence Gov. had to intervene.
If that were the case, then i  may not be able to use the above premises  to reach the conclusion. Conclusion CAN be TRUE on its own but we won't be able to use the PREMISES to reach the CONCLUSION in discussion.''

I think, thats what you meant, when you said:  ''For the exact argument to hold up'' in your explanation''

stackskillz · Answer

Conc : Insurance is partly responsible for the high rate of bank failures.
 Note  - Keep in mind the conclusion is regarding the insurance. The remaining statements in the argument, post the conclusion are premises that support the economist's position.

(A) Bank failures are caused when big borrowers default on loan repayments - States another factor causing bank failures. Doesn't justify economist viewpoint.  Drop 
(B) A significant proportion of depositors maintain accounts at several different banks. - The logical implication being that depositors protect themselves against bank failures if the govt. didn't step in. But that assumption breaks, since government does provides insurance against bank failure. This information doesn't help with the economist's viewpoint.  Drop 
(C) The more a depositor has to deposit, the more careful he or she tends to be in selecting a bank - Explains a factor that makes depositor more selective. However, doesn't justify the cause-effect link between insurance and bank failure.  Drop 
(D) The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures. Okay - This option seems to support the conclusion by eliminating an alternate cause. Let's negate to check - The difference in interest rates paid to depositor is a significant factor. That's good to know, however, this negation doesn't hurt the argument, since we only claim that insurance is partly responsible, not the sole reason, for the high rate of bank failures.  Drop 
(E) Potential depositors are able to determine which banks are secure against failure - Negating this seems to break the conclusion, i.e., if depositor aren't able to identify which banks are more secure against failure, then the economist's viewpoint falls apart, i.e., insurance could be partly responsible, but it won't be due to lack of dilligence from the depositors as indicated in the argument.  Keep

dhairya18 · Answer

Line of Reasoning 1: Cause-Effect Argument (Primary)
Government Deposit Insurance -> Removal of Depositor Selectivity -> Higher Rate of Bank Failures

Line of Reasoning 2: Comparison Argument (Secondary)
Market Discipline (Uninsured Depositors) > Regulatory Discipline (Insured Depositors) in Preventing Bank Failures

Assumptions
Assumption 1: Average depositors have sufficient financial literacy and information to assess whether a bank is secure against failure.

Assumption 2: Depositors would prioritize bank safety over other features like interest rates, low fees, or geographic convenience if insurance were removed.

Assumption 3: Banks would adapt to depositor scrutiny by adopting safer financial practices rather than taking high risks to offer higher yields.

Assumption 4: Removing deposit insurance would not lead to panic-driven bank runs that increase bank failure rates regardless of individual bank stability.

Assumption 5: Lack of depositor monitoring is a major driver of bank failures rather than broader macroeconomic downturns or mismanagement.

Bank depositors in the United States are all financially protected aga

Prep Toolkit

Top 5 GMAT Debrief Videos

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia

GMAT Critical Reasoning (CR) Questions

Bank depositors in the United States are all financially protected aga

Prep Toolkit

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia