Question

Consider the balance sheets of two banks: Wells America and Bank of Fargo. Assume that the legal reserve requirement is 10 percent of all deposits. A. Suppose that Wells America has $200 billion in checkable deposits, $30 billion in reserves, $60 billion in securities, and $150 billion in loans. Draw a balance sheet (T-account) for Wells America. What is the dollar value of its bank capital? How much does Wells America hold in excess reserves? How is this related to liquidity risk? Explain. Assume that Bank of Fargo has the following balance sheet information: $240 billion in checkable deposits, $166 billion in loans, $10 billion in bank capital, and no excess reserves. Show the balance sheet for Bank of Fargo. What are the dollar values of its reserves and securities? What is the leverage ratio for each bank? Which bank is more likely to become insolvent in the event of a large decrease in the dollar value of its securities? Explain.

Answer 1

For Wells America,

Balance Sheet

Assets	$ Billion	Liabilities	$ Billion
Reserves	30	Checkable Deposits	200
Securities	60	Capital	40
Loans	150
Total	240		240

So Bank Capital = 240 - 200 = $40 billion

Required Reserves = 10% * 200 = $20 billion

So Excess Reserves = 30 - 20 = $10 billion

Higher Excess reserves and capital helps the banks in times of higher withdrawal Capital also absorbs loss if arising from loans securities etc. Hence for Liquidity both becomes critical

For,

Banks of Fargo,

Balance Sheet

Assets	$ Billion	Liabilities	$ Billion
Reserves	24	Checkable Deposits	240
Securities	60	Capital	10
Loans	166
Total	250		250

Reserves = 10% * 240 = $24 billion

Securities = 250 - 166 - 24 = $ 60 billion

Leverage Ratio for Wells America = 40/ 240 = 16.67%

Leverage ratio for banks of fargo = 10/ 250 = 4%

Hence Bank B is at a higher risk due to lower capital, lower leverage ratio and low reserves