Question

en 25 12 points Save Ans Consider a simple bank that has assets of $120, checking deposits of $80, and capital of $40. Recall from chapter 4 that checking deposits are liabilities of a bank. a) Complete the bank's balance sheet Assets Bank Assets Liabilities Checking Deposits Net Worth Capital b) Now suppose that the perceived value of the bank's assets falls by $10. Find the new value of bank's capital c) What is the leverage ratio? Show your work. d) Suppose the deposits are insured by the government. Given the decline in the value of bank capital, do you think that the depositors should be concerned? Explain.

Answer 1

a.

As per the data, the balance sheet is as below:

Balance sheet

Assets	$	Liabilities	$
Bank assets	120	Checking Deposits	80
		Net Worth
		Capital	40
Total	120	Total	120

b.

New bank capital = 30

Since the asset decreases by 10, it effects on capital account in order to make the two sides “total” equal.

New bank capital = Existing – Decrease in assets

                            = 40 – 10

                            = 30

c.

Leverage ratio = Checking deposits / New bank capital

                        = 80 / 30

                        = 2.67 (Answer)

d.

Answer: yes; they should concern.

The leverage ratio (2.67) is very high, indicating high dependency on debt; this happens because of lower capital. The desired ratio should be around 1, which is not happening here.

Although deposits are insured, it usually takes time in the process of insurance once the bank fails to meet depositors’ dues. Checking deposits are actually made for operational needs of a firm, which may be hampered because of insurance formalities.

Therefore, depositors should be concerned.