The following sub-questions are about liquidity management and asymmetric information problems in the financial system and their effect on economic activity.

a)Explain how a bank facing a sudden deposit withdrawal solves the problem of liquidity. What are the costs related to each case? [6 marks)

b)Consider the situation where balance sheets of banks are growing worse and because of this, these banks are failing at the same time.How does such a condition affect economic activity? [6 marks]

c)Changes in what financial variable indicate that asymmetric information problems in the financial sector are increasing? [6 marks]