Question

Part 2: Money Q5. Consider the Balance sheets of Bank A and Bank B: (10 points) Assets Bank A Liabilities and Owners' Equity Reserves 200 Deposits 1000 Loans 1000 Debt (bond issued by Bank A) 500 Stocks 800 Capital (Owner's Equity) 500 Assets Bank B Liabilities and Owners' Equity Reserves 400 Deposits 2000 Loans 1600 Debt (bond issued by Bank B) 400 Stocks 1000 Capital (Owner's Equity) 600 i. What is the Reserve-Deposit Ratio (rr) for bank A, What is the reserve deposit ratio for Bank B? ii. What is the definition of Leverage ratio? What is the leverage ratio of Bank A and Bank B? iii. Now assume that due to a recession, the value of the stocks of the banks purchased, have declined by 25%. Moreover, the banks cannot get back 25% of their loans because the borrowers (other institutions and households) filed bankruptcy due to the recession. What will look like the Balance Sheet of Bank A and Bank B? 2 iv. Which of the above banks may become insolvent during the recession? Why? explain your answer using their balances sheet. v. Do you think regulators and policymakers can prevent these kinds of problems in future? How?

Answer 1

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Question:

Answer:

(i). Answer:

Reserve-deposit Ratio: It is also know as reserve ratio. reserve-deposit ratio is the the % of total deposit that is required for a bank to keep with the central bank or its own wallet.

Reserve-deposit Ratio (for bank B) = (Reserve maintained with Central Bank / Bank Deposits) * 100%

= (400/2000) * 100

= 0.2* 100 = 20%

Reserve-deposit Ratio (for bank B) = 20%

Reserve-deposit Ratio (for bank A) = (Reserve maintained with Central Bank / Bank Deposits) * 100%

= (200/1000) * 100

= 0.2 * 100 = 20%

Reserve-deposit Ratio (for bank A) = 20%

(ii). Answer:

Leverage Ratio:

Leverage ratio refers to the capital structure of a company that show that  how much capital comes in the form of debt. Its assesses the ability of a company to meet its financial obligations in future or in current position. There are many tools and techniques to measure this ratio but here i will use debt to assets ratio.

Leverage Ratio = Debt-to-Assets Ratio = Total Debt / Total Assets

Leverage Ratio (for bank B) = 400/3000 = 0.13

Leverage Ratio (for bank B) = 0.13

Leverage Ratio (for bank A) = 500/2000 = 0.25

Leverage Ratio (for bank A)= 0.25

(iii). Answer:

Loss in stocks = 25%

Loan default = 25%

Both are the part of assets class of balance sheet.

Impact on balance sheet on bank B:

Impact on value of stock = 1000 - (1000*25%) = 750

Impact on value of loan = 1600 - (1600*25%) = 1200

Impact on balance sheet on bank A:

Impact on value of stock = 800 - (800*25%) = 600

Impact on value of loan = 1000 - (1000*25%) = 750

Here the total assets of bank A will reduced by 1350 and bank B by 1950.

Now,

Total assets of bank B = 1050

Total assets of bank A =650

Thank You