Question

Question B6. (15 marks) BIG Bank's balance sheet is listed below. Market yields and durations (in years) are in parenthesis, and amounts are in millions. Assets Cash Interbank lending (1.5%, 0.05) T-bonds (7.50%, 8) Liabilities and equity $20 Demand deposits $300 $200 Savings accounts (4.5%, 0.50) $200 $100 Interbank borrowings (1.5%, $200 0.01) Consumer loans (6%, 2.50) $400 Wholesale funding (5.5%, 0.25) $400 $400 Business loans (5.8%, 10) Variable-rate mortgages, repriced at quarter (6.3%, 0.25) $380 Equity $400 Due to turbulence in overseas markets, the cost of wholesale funding has increased to 6%. The RBA reacts by reducing the target cash rate to 1%. a) Briefly explain if BIG Bank's cost of funding will increase or decrease (given the current liability structure). (4 marks) b) Suggest two likely changes that BIG Bank will implement on its liability side. (3 marks) c) Estimate a minimum and maximum value of the new variable mortgage rate that BIG Bank is likely to charge its customers. Explain your answer. (4 marks) d) Some financial reporters argue that BIG Bank is too greedy and should always pass on the interest changes decided by the RBA. Comment. (4 marks)

Answer 1

Ans. a): There will be increase in cost of funding of BIG Bank because increase in cost of wholesale funding will also impact to BIG Bank. As BIG Bank also has to offer increased return to attract and retain wholesale funding.

Ans. b) To make right mix of liability portfolio, Big Bank may invite more saving accounts funding as there will be little impact of increase in wholesale funding. Similarly Big Bank can also invite more demand deposit.

Ans. c): Maximum Range will be 6.8% and minimum will be 6.3%. Because increase in cost of wholesale funding will compel to increase mortgage rate to maintain same level of profit. On scrutiny, we can find that there is 0.8% higher rate of mortgage on cost to wholesale funding .

Ans. d): If Big Bank has to maintain same level of operation, it has to pass excess cost burden to its customers, otherwise Big Bank will start loosing its profit.