Question

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

Assets	Liabilities
Reserves                        $175	Deposits                               $1,250
Loans                              $1,800	Bank Capital                         $725

Assume a 10% reserve requirement. If there is a sudden withdrawal of deposits of $100:

What problem does this create for you as the bank owner? Briefly explain what options are available to you to deal with the resulting problem. Answer this question based on the course material.

Which of these options are you most likely to choose? Why?

Answer 1

Answer )

Before taking any actions, the bank’s balance sheet would be:

Assets	Liabilities
Reserves $75	Deposits $ 1150
Loans $ 1800	Bank Capital $ 725

If the required reserve ratio is 10%, then this bank is violating its required reserve level by $40 m. The bank can take four basic actions:

1. Borrow $40 m. on the Federal Funds market in which case its balance sheet would be:

Assets	Liabilities
Reserves $ 115	Deposits                               $1,150
Loans $1800	Bank Borrowings $40
	Bank Capital $725

2. Borrow $40 m. from the Federal Reserve Discount Window in which case its balance sheet would be:

Assets	Liabilities
Reserves                        $115	Deposits $1,150
Loans                              $1,800	Federal Reserve Borrowings $40 m.
	Bank Capital $725

3. Sell $20 million of loans (or not renew $20 million of loans that come due at the same time of  the deposit outflow.

Assets	Liabilities
Reserves                        $115	Deposits                               $1,150
Loans                              $1,760	Bank Capital                         $725

4. While none exist on this bank’s balance sheets, most banks hold other types of assets (e.g. treasury bills) which could be sold instead of loans. Doing so transforms one type of asset (a treasury bill) into another (reserves). All 4 choices involve a cost. Choices #1 and #2 raise the expenses of the bank and choices #3 and #4 reduce the bank’s revenues.