Question

The financial crisis compelled banks to reduce their leverage sharply.   Consider the following two views of the balance sheet of a bank before and after the financial crisis.

Bank Balance Sheet: View 1 (in millions)			Bank Balance Sheet: View 2 (in millions)
Assets	Liabilities		Assets	Liabilities
Reserves $30	Deposits $800		Reserves $30	Deposits $200
Loans $820	Other borrowed funds $90		Loans $820	Other borrowed funds $600
Securities $150	Bank capital $110		Securities $150	Bank capital $90

Calculate the leverage ratios for each view.

Instructions: Enter your responses rounded to two decimal places.

View 1: Leverage ratio =

View 2: Leverage ratio =

Which balance sheet view is more likely to be that of the bank after the financial crisis?

• View 2

• View 1

Answer 1

Solution :

The leverage ratio of a bank is calculated using the formula

Leverage Ratio = Total assets / Bank capital

Calculation of Leverage ratio of View 1 :

As per the information given in the question with respect to view 1 we have

Total assets = Reserves + Loans + Securities

Thus total Assets = $ 30 + $ 820 + $ 150 = $ 1,000

Bank Capital = $ 110

Applying the above values in the Leverage Ratio formula we have

= $ 1,000 / $ 110

= 9.0909  

= 9.09 ( when rounded off to two decimal places )

Thus the Leverage Ratio of View 1 = 9.09

Calculation of Leverage ratio of View 2 :

As per the information given in the question with respect to view 2 we have

Total assets = Reserves + Loans + Securities

Thus total Assets = $ 30 + $ 820 + $ 150 = $ 1,000

Bank Capital = $ 90

Applying the above values in the Leverage Ratio formula we have

= $ 1,000 / $ 90

= 11.1111

= 11.11 ( when rounded off to two decimal places )

Thus the Leverage Ratio of View 2 = 11.11

As per the information given in the question the financial crisis compelled the banks to reduce their leverage sharply.

Thus the Balance sheet: view 1, with the lower leverage ratio of 9.09, is more likely to be the bank after the financial crisis, which was compelled to reduce its leverage sharply.

Thus the solution is View 1.