Question

BIG Bank's balance sheet is listed below. Market yieilds and duratons (in years) are in parenthesis, and amounts are in millions. Assets Cash Interbank lending (1.5%, 0.05) T-bonds (7.50%, 8) $20 Demand deposits $200 | Savings accounts (4.5%, 0.50) $100 | Interbank borrowings (1.5%, $400 | Wholesale funding (5.5%, Llablitles and equlty $300 $200 $200 $400 0.01) Consumer loans (696, 2.50) 0.25) Business loans (5.8%, 10) $380 Equity $400 $400 Variable-rate mortgages repriced at quarter (6.3%, 0.25) 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 (4 marks) b) Suggest two likely chariges 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 liability structure) 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

a) Yes cost of funding will increase for the BIG Bank. Though, 0.5% increase in wholesale funding has been offset by 0.5% reduction in target cash rate or interbank borrowings. But, in absolute terms, the cost of wholesale funding (interest payment) is increased by $2mn while interbank borrowings have been reduced by $1mn only, so difference is if $1mn.

b) Two likely changes in liability side:

i) Increase the demand deposits

ii) Increase interbank borrowings/reduce wholesale funding