Question

1.     Reserves 10 million               Deposits 90 million

        Loans    90 million               Bank Capital 10 million

a. Bank XYZ can withstand a 5% drop in loan value and still be “well capitalized”. Well capitalized means an Equity/Asset ratio of 8%. True/ False Please explain

b. Bank XYZ can withstand a 5% drop in loan value and still be “well capitalized”. Well capitalized means an Equity/Asset ratio of 6%. True/False Please explain

c. Bank XYZ can withstand a 10% drop in loan value and still be “well capitalized”. Well capitalized means an Equity/Asset ratio of 8%. True/ False Please explain

            d. Bank XYZ can withstand a 5% drop in loan value and still be “well capitalized”. Well capitalized means an         Equity/Asset ratio of 8%.     True/False Please explain

Answer 1

Solution

a. True

Initially the assets of a bank = Reserves + Loans i.e.,10 million + 90 million => 100 million

After 5 % drop in loans,the loasn reduce by 4.5 million

So ,Assets = 95.5 Million ; Equity / Asset Ratio = (10 / 95.5) => 10.47 % which is above 8 % .

So, the bank XYZ is well capitalized

  

b.True.

After 5 % drop in loans,the loasn reduce by 4.5 million

So ,Assets = 95.5 Million ; Equity / Asset Ratio = (10 / 95.5) => 10.47 % which is above 6 % .

So, the bank XYZ is well capitalized

c. True

After 10 % drop in loans,the loans reduce by 9.0 million

So ,Assets = 91 million ; Equity / Asset Ratio = (10 / 91) => 10.98 % which is above the ratio of  8 % .

So, the bank XYZ is well capitalized

d. True

After 5 % drop in loans,the loans reduce by 9.0 million

So ,Assets = 91 million ; Equity / Asset Ratio = (10 / 91) => 10.47 % which is above the ratio of  8 % .

So, the bank XYZ is well capitalized

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