Question

A commercial bank’s T-account in 2018 is shown as below

Assets

Loans: $800

Securities: $100

Reserves: $60

Liabilities plus equity

Deposits: $900

Borrowing: $0

Equity: ?

The bank pays 10% for the bank deposit to the depositors; the average interest rate on the loans is 15%; the returns to its securities is 10%; and the interest rate earned from the reserves is 4% .

1. Calculate the value of equity, the value of capital ratio and the leverage ratio?

2. What is the return on equity?

3. If $ 100 of the loans is defaulted, what does the new T-Account look like? What is the new equity value? Will the bank become insolvent?

4. If a customer want to withdraw $200 dollar, the commercial bank first use its liquid assets (e.g., securities and reserves) to pay the customer. However, the liquid assets ($160) is not enough to pay all the $200 withdraws. As a result, the commercial bank has to sell the loans that it holds. Since loans are not liquid, the commercial bank can only sell it at 50% discount. For this scenario, what does the new T-Account look like after paying the deposit withdraws? Will the bank become insolvent?

Answer 1

As Per Chegg Rules i will give first answer only

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