Question

You are the owner of Bank of Pecunia, which currently has the following balance sheet:

Assets	liabilities
Reserves. $3600	deposits. $16000
loans. $14400	bank capital $2000

a. Assume a 10% reserve requirement. If there is a sudden withdrawal of deposits of $2,400, what problem will your bank be facing as a result? Draw the new balance sheet (after the withdrawal) and be specific, including the extent (i.e. $ value) of your problem, for full credit.

b. Explain two (2) options available to you (as the bank owner) to deal with the resulting problem. What is typically the best option available to banks for dealing with this type of problem? Explain.

c. Assume that $14,400 of Bank of Petunia’s assets are interest-rate sensitive (i.e. variable interest rate), and that $16,000 of its liabilities are interest-rate sensitive (i.e. variable interest rate). Conduct a gap analysis for the bank, and show what will happen to bank profits if interest rates rise by 3 percentage points. Show your work and briefly explain.

Answer 1

BALANCESHEET

Liabilities	Amount($)	Assets	Amount ($)
Bank Capital	2000	Reserves	3600
Deposits	16000	Loan	14400
TOTAL	18000	TOTAL	18000

Answer (a) Assuming the Reserve Requiremet of 10%, if the withdrawls of deposits worth $ 2400 happens, the bank may suffer a short -term working capital crunches. Moreover, the bank will be left with lesser money which it can offer to public in the form of loans thereby affecting the bank's interest income. Finally, the banks will have to reduce its reserves in order to meet the requirements.

BALANCESHEET

Liabilities	Amount($)	Assets	Amount ($)
Bank Capital	2000	Reserves(3600-2400)	1200
Deposits(16000-2400)	13600	Loan	14400
TOTAL	15600	TOTAL	15600

Answer(b) There may be two options available with the bank to deal with the above problem:-

1. Raising of Fresh capital by issuing new shares in the market

2. Selling some of its assets in short -term to deal with the problem.

Answer (c) Assuming that the both assets and liabilities of Bank of Petunia are interest-sensitive and the interest rate goes up by 3%, the deposits with bank will increase as the increase in interest rates will attaract more deposits from the customers. On the other hand, the demand for loans will decrease due to high interest rate.The whole scenario will result in the overall Decrease in the Bank's Profit. In short, the interest income from disbursement of loans will decrease on one hand while the interest payment burden on customer's deposits will increase. This will result in a decrease in overall proift of the bank.