Question

The financial information of BIT Bank and NAT Bank is shown as follows: BIT Bank (in millions) Assets Reserves Loans $48 Deposits $360 Bank Capital Liabilities $340 $68 NAT Bank (in millions) Assets Reserves Loans $48 Deposits $360 Bank Capital Liabilities $400 $8 Assume that both BIT Bank and NAT Bank have the same net profit after tax of $8 million. a. Calculate for each bank, BIT Bank and NAT Bank, its: i. return on assets (ROA); ii. return on equity (ROE); and iii. leverage ratio. Show all your calculations. 7 marks b. With reference to your answers in 5(a), which Bank (Bank BIT or Bank NAT) is more attractive for shareholders? Show your calculations to explain your answers. 5 Marks C. Which bank (Bank BIT or Bank NAT) is riskier in case of loan depreciation at $60 million? Explain. Show your calculations to explain your answers. 6 marks

Answer 1

a. i. ROA = Return on assets = Net Income / Total Assets

BIT Bank: ROA = 8/408 = 0.0196078
NAT Bank: ROA = 8/408 = 0.0196078

ii. ROE = Net income / Bank capital

BIT Bank: ROE = 8/68 = 0.117647059
NAT Bank: ROE = 8/8 = 1

iii. Leverage ratio = Deposits / bank capital

BIT Bank: Leverage ratio = 340/68 = 5
NAT Bank: Leverage ratio = 400/8 = 50

b. NAT bank is more attractive for shareholders as it has an ROE of 1, as compared to the ROE of 0.11764 of BIT bank, This means that NAT bank generates more capital per unit of equity investment. While the ROA of both banks are the same, the ROE and Leverage ratios differ. The Leverage ratio of NAT banks is high, but if they are able to service their debt, shareholders will be more than satisfied with an ROE of 1.

c. NAT Bank is riskier in case of loan depreciation. This is because it has a higher leverage ratio and has a higher risk of not being able to service its debt. It has a leverage ratio of 50 as compared to a leverage ratio of 5 for BIT bank. A loan of $60 million will add to the risk of the bank not being able to pay back its debts.