Question

Suppose that there is a sharp decline in the risk taking incentives of the financial sector and there is increasing demand for safe securities such as U.S. treasury bills. How does that affect the balance sheets of the banks in the U.S?

Answer 1

1. The question indirectly is asking about the impact of decrease in the value of share price on the balance sheets of the banks,
2. There might be two cases, decrease in the value of shares of the bank itself and decrease in the value of shares of the entities in which the banks might have invested.
3. In the later case it is as simple as that, the value of investment on the asset side of the balance sheet gets decreased resulting in decrease in the value of assets of the bank. This will also lead to a lot other effects also, impairment, revaluation etc;
4. In the first case, there won't be any effect on the balance sheet, because company's carry shares at book value and not at the market value of the share, therefore share market fluctuations don't have any impact on balance sheet in this case.